Question

15. Calculating Profitability Index

YEAR	Cash flow
0	-$16700
1	9700
2	7800
3	4300

a. What is the profitability index if the appropriate discount rate is 10% for the following cash flows?

b. What if the discount rate is 15 percent?

c. What if the discount rate is 22%?

Answer 1

Profitability Index:

It is reatio of Present value of future cash inflows to Initial amount invested.

PI = PV of Cash inflows / PV of Cash Outflows

If PI > 1, Project will be accepted,

   PI = 1, Indifference point. Project will be accepted/ Rejected.

   PI < 1, Project will be rejected.

a) profitability index @ 10%

Year	CF	PVF @10 %	Disc CF
1	$         9,700.00	0.9091	$     8,818.18
2	$         7,800.00	0.8264	$     6,446.28
3	$         4,300.00	0.7513	$     3,230.65
PV of cash Inflows			$   18,495.12
PV of cash Outflows			$   16,700.00
Profitability Index:			1.11

Accept the Project as PI is > 1

b) profitability index @ 15%

Year	CF	PVF @15 %	Disc CF
1	$         9,700.00	0.8696	$     8,434.78
2	$         7,800.00	0.7561	$     5,897.92
3	$         4,300.00	0.6575	$     2,827.32
PV of cash Inflows			$   17,160.02
PV of cash Outflows			$   16,700.00
Profitability Index:			1.03

Accept the Project as PI is > 1

c) profitability index@ 22%

Year	CF	PVF @22 %	Disc CF
1	$         9,700.00	0.8197	$     7,950.82
2	$         7,800.00	0.6719	$     5,240.53
3	$         4,300.00	0.5507	$     2,368.04
PV of cash Inflows			$   15,559.39
PV of cash Outflows			$   16,700.00
Profitability Index:			0.93

Reject the Project as PI < 1