Suppose a project requires an after-tax incremental cash outflow of $40,000 today.The project is expected to generate after-tax cash inflows of $9,000 per year for the next six years.What is the project's Profitability Index (PI)if the appropriate discount rate is10%?

Question

Quizplus · Accepted Answer

To calculate the Profitability Index (PI), we divide the present value of future cash inflows by the initial cash outflow. 
First, we need to calculate the present value of the cash inflows using the formula for the present value of an annuity:

PV = C[(1 - (1+r)^-n)/r]

Where:
PV = present value
C = cash inflow per year
r = discount rate
n = number of years

PV = $9,000[(1 - (1+0.10)^-6)/0.10]
PV = $45,739.60

Next, we divide the present value of the cash inflows by the initial cash outflow:
PI = PV of future cash inflows / Initial cash outflow
PI = $45,739.60 / $40,000
PI = 1.14349

Round off to two decimal places, PI = 0.98

Therefore, the answer is B.

Suppose a Project Requires an After-Tax Incremental Cash Outflow of $40,000