Question

Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 9 percent, and that the maximum allowable payback and discounted payback statistics for the project are 2.0 and 3.0 years, respectively.

Time:	0	1	2	3	4	5	6
Cash flow:	–$7,100	$1,100	$2,300	$1,500	$1,500	$1,300	$1,100

Use the PI decision rule to evaluate this project. (Do not round intermediate calculations and round your final answer to 2 decimal places.)

PI=_____

Answer 1

Calculation of profitability Index (PI) of the project
Profitability Index = Present value of future cash inflows / Initial Investment
PI rule states that , if PI is greater than 1 then accept the project otherwise not.
Present value of future cash inflows
Year	Cash flow	Discount Factor @ 9%	Present Value
1	$1,100.00	0.91743	$1,009.17
2	$2,300.00	0.84168	$1,935.86
3	$1,500.00	0.77218	$1,158.28
4	$1,500.00	0.70843	$1,062.64
5	$1,300.00	0.64993	$844.91
6	$1,100.00	0.59627	$655.89
Present value of future cash inflows			$6,666.76
Profitability Index = $6666.76 / $7100
Profitability Index = 0.94
PI is less than 1 , hence project should not be accepted.