Question

Year	Cash Flow
0	−$8,600
1	5,700
2	3,200
3	5,700

  

Required :

(a)	What is the profitability index for the cashflows if the relevant discount rate is 10 percent?
	(Click to select)  $1.45  $1.408  $1.338  $1.478  $1.366

  

(b)	What is the profitability index for the cashflows if the relevant discount rate is 14 percent?
	(Click to select)  $1.249  $1.381  $1.315  $1.355  $1.276

  

(c)	What is the profitability index for the cashflows if the relevant discount rate is 24 percent?
	(Click to select)  1.158  1.068  1.18  1.124  1.09

Answer 1

Ans : Profitability Index measures the ratio of Present value of Future Cash flows to Initial Cost of Investment. It is also called as Profit Investment Ratio or Value Investment Ratio.

It is calculated as : Present Value of Cash Inflows / Present Value of Cash Outflows

a) If Discount Rate is 10%

Year	Cash InFlow	Present Value Factor @ 10%	Present Value of Cash InFlows
1	$5,700	0.9091	$5,181.87
2	$3,200	0.8264	$2644.48
3	$5,700	0.7513	$4,282.41
Total	$12,108.76

Profitability Index = $12,108.76 / $8,600 = 1.408

b) If Discount Rate is 14%

Year	Cash InFlow	Present Value Factor @ 14%	Present Value of Cash InFlows
1	$5,700	0.8772	$5,000.04
2	$3,200	0.7695	$2,462.4
3	$5,700	0.6750	$3,847.50
Total	$11,309.94

Profitability Index = $11,309.94 / $8,600 = 1.315

c) If Discount Rate is 24%

Year	Cash InFlow	Present Value Factor @ 24%	Present Value of Cash InFlows
1	$5,700	0.8065	$4,597.05
2	$3,200	0.6504	$2,081.28
3	$5,700	0.5245	$2,989.65
Total	$9,667.98

Profitability Index = $9,667.98 / $8,600 = 1.124


Ans : Profitiabality Index

At 10% = 1.408
At 14% = 1.315
At 24% = 1.124