Talley Manufacturing has a project that requires an initial investment of $60 000 and has the following expected stream of cash flows:
$$\begin{array} { c c }
\text { Year } & \text { Annual cash flow } \
\hline 1 & \$40000 \
2 &\$ 30000 \
3 & \$20000
\end{array}$$
Assuming the company's cost of capital is 14 per cent,what is the profitability index for the project?

Question

Talley Manufacturing has a project that requires an initial investment of $60 000 and has the following expected stream of cash flows:
$$\begin{array} { c c } 
\text { Year } & \text { Annual cash flow } \
\hline 1 & \$40000 \
2 &\$ 30000 \
3 & \$20000
\end{array}$$
Assuming the company's cost of capital is 14 per cent,what is the profitability index for the project?

Quizplus · Accepted Answer

The profitability index (PI) is calculated by dividing the present value (PV) of future cash flows by the initial investment. Using a discount rate of 14%, the PV of each cash flow is: Year 1: $40,000 / (1 + 0.14)^1 = $35,087.72 Year 2: $30,000 / (1 + 0.14)^2 = $23,102.31 Year 3: $20,000 / (1 + 0.14)^3 = $13,966.25 Total PV of cash flows = $35,087.72 + $23,102.31 + $13,966.25 = $72,156.28 PI = Total PV of cash flows / Initial Investment = $72,156.28 / $60,000 = 1.2026, rounded to 1.19.

Talley Manufacturing Has a Project That Requires an Initial Investment Year Annual cash flow 1$400002$300003$20000\begin{array} { c c } \text { Year } & \text { Annual cash flow } \\\hline 1 & \$40000 \\2 &\$ 30000 \\3 & \$20000\end{array} Year 123​ Annual cash flow $40000$30000$20000​​

Talley Manufacturing Has a Project That Requires an Initial Investment $\begin{array} { c c } \text { Year } & \text { Annual cash flow } \\\hline 1 & \$40000 \\2 &\$ 30000 \\3 & \$20000\end{array}$