A project has cash flows of -$152,000, $60,800, $62,300 and $75,000 for Years 0 to 3, respectively. The required rate of return is 13 percent. What is the profitability index? Should you accept or reject the project based on this index value?
A) .93; accept
B) 1.07; accept
C) 1.02; accept
D) .93; reject
E) 1.07 reject

Question

Quizplus · Accepted Answer

To calculate the profitability index, we need to find the present value of each cash flow using the required rate of return of 13%.

PV of cash flow at Year 0 = -$152,000 / (1+0.13)^0 = -$152,000
PV of cash flow at Year 1 = $60,800 / (1+0.13)^1 = $53,672.57
PV of cash flow at Year 2 = $62,300 / (1+0.13)^2 = $48,520.02
PV of cash flow at Year 3 = $75,000 / (1+0.13)^3 = $50,114.23

Total present value of cash flows = -$152,000 + $53,672.57 + $48,520.02 + $50,114.23 = $999.82

Profitability index = Total present value of cash flows / Initial investment
Profitability index = $999.82 / $152,000 = 1.02

Since the profitability index is greater than 1, we should accept the project.

A Project Has Cash Flows of -$152,000, $60,800, $62,300 and $75,000