Calculate the profitability index for a project with the following cash flows. Assume a cost of capital of 10%

Question

Quizplus · Accepted Answer

To calculate the profitability index, we need to divide the present value of cash inflows by the initial investment. 
The present value of cash inflows for the project is calculated using a discounted cash flow analysis:

Year 1: $200/(1 + 0.10)1 = $181.82 
Year 2: $300/(1 + 0.10)2 = $247.93 
Year 3: $400/(1 + 0.10)3 = $308.17 
Year 4: $500/(1 + 0.10)4 = $375.13 
Year 5: $600/(1 + 0.10)5 = $432.98

Total present value of cash inflows = $1546.03

The initial investment is $1200.

Profitability index = Present value of cash inflows / Initial investment 
Profitability index = $1546.03 / $1200 
Profitability index = 1.29

Therefore, the best choice is to select Choice C, which has a profitability index of 1.24.

Calculate the Profitability Index for a Project with the Following