Question

What is the profitability index of a project that costs $8,000 and provides cash flows of $2,100 in years 1 and 2 and $4,100 in years 3 and 4? The discount rate is 10%. (Do not round intermediate calculations. Round your answer to 4 decimal places.)

Answer 1

Profitability index is calculated using the below formula:

Profitability Index= Net present value + Initial investment/ Initial investment

Net present value is calculated using a financial calculator by inputting the below:

• Press the CF button.
• CF0= -$8,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for each year should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the third cash flow cash flow, press the NPV button and enter the discount rate of 10%.
• Press enter after that. Press the down arrow and CPT buttons to get the net present value.

The net present value of cash flows is $1,525.37.

Profitability Index= $1,525.37 + $8,000/ $8,000

                                   = $9,525.37/ $8,000

                                   = 1.1907.

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