Sun Company is considering purchasing new equipment costing $350,000. Sun's management has
Estimated that the equipment will generate cash flows as follows:
$$\begin{array} { | l | l | }
\hline \text { Year 1 } & \$ 100,000 \
\hline \text { Year 2 } & \$ 100,000 \
\hline \text { Year 3 } & \$ 125,000 \
\hline \text { Year 4 } & \$ 125,000 \
\hline \text { Year 5 } & \$ 75,000 \
\hline
\end{array}$$ What is the profitability index of the equipment if the discount rate is 10%?
Note: Present value and future value tables are needed.

Question

Sun Company is considering purchasing new equipment costing $350,000. Sun's management has
Estimated that the equipment will generate cash flows as follows:
$$\begin{array} { | l | l | } 
\hline \text { Year 1 } & \$ 100,000 \
\hline \text { Year 2 } & \$ 100,000 \
\hline \text { Year 3 } & \$ 125,000 \
\hline \text { Year 4 } & \$ 125,000 \
\hline \text { Year 5 } & \$ 75,000 \
\hline
\end{array}$$ What is the profitability index of the equipment if the discount rate is 10%?
Note: Present value and future value tables are needed.

Quizplus · Accepted Answer

The profitability index (PI) is calculated by dividing the present value of future cash flows by the initial investment. Using a discount rate of 10%, the present value (PV) of each year's cash flows is calculated as follows: Year 1: $100,000 / (1 + 0.10)^1 = $90,909.09 Year 2: $100,000 / (1 + 0.10)^2 = $82,644.63 Year 3: $125,000 / (1 + 0.10)^3 = $94,169.42 Year 4: $125,000 / (1 + 0.10)^4 = $85,608.57 Year 5: $75,000 / (1 + 0.10)^5 = $46,947.01 Adding these amounts gives a total present value of future cash flows of $400,278.72. The initial investment is $350,000. Thus, the profitability index is $400,278.72 / $350,000 = 1.14.

Sun Company Is Considering Purchasing New Equipment Costing $350,000 What Is the Profitability Index of the Equipment If the Management