Suppose you have an opportunity to invest in a project, which is expected to generate $6,800 in year 1, $7,200 in year 2, and $7,500 in year 3.The appropriate risk-adjusted discount rate for the project is 10.5%.The project's initial investment is $15,000.What is the profitability index?

Question

Quizplus · Accepted Answer

The profitability index (PI) is calculated as the present value of future cash flows divided by the initial investment. The present value of cash flows is calculated using the formula: PV = CF1/(1+r)^1 + CF2/(1+r)^2 + CF3/(1+r)^3. Substituting the given values, PV = $6,800/(1+0.105)^1 + $7,200/(1+0.105)^2 + $7,500/(1+0.105)^3 = $6,151.61 + $5,889.92 + $5,474.77 = $17,516.30. The PI is $17,516.30 / $15,000 = 1.17.

Suppose You Have an Opportunity to Invest in a Project