Question

A company is considering three projects (G, H, and I) that have the following expected cash flows and risk-adjusted discount rates.

Project	Discount Rate (k)	Initial Investment	Year 1	Year 2	Year 3	Year 4	Year 5
G	9.0%	($800)	$200	$200	$200	$200	$250
H	5.0%	($500)	$300	$50	$50	$50	$200
I	7.0%	($400)	$90	$120	$150	$100	$50

The company wants to rank the projects based on PI. Which project has the highest PI?

1. Project G
2. Project H
3. Project I

Answer 1

Solution:-

To Calculate Profitability Index-

Formula of Profitability Index =

Project G-

Present Value of Project G
Year	Cash flow	Discounting Factor @9%	Present Value
1	200	0.917	183.49
2	200	0.842	168.34
3	200	0.772	154.44
4	200	0.708	141.69
5	250	0.650	162.48
		Present Value	810.43

Profitability Index =

Profitability Index = 1.013

Project H-

Present Value of Project H
Year	Cash flow	Discounting Factor @5%	Present Value
1	300	0.952	285.71
2	50	0.907	45.35
3	50	0.864	43.19
4	50	0.823	41.14
5	200	0.784	156.71
		Present Value	572.10

Profitability Index =

Profitability Index = 1.1442

Project I-

Present Value of Project I
Year	Cash flow	Discounting Factor @7%	Present Value
1	90	0.935	84.11
2	120	0.873	104.81
3	150	0.816	122.44
4	100	0.763	76.29
5	50	0.713	35.65
		Present Value	423.31

Profitability Index =

Profitability Index = 1.0583

The Company should select Project H as Higher PI then Others.

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