Mulligan, Inc. is currently considering an eight-year project that has an initial outlay or cost of $140,000. The cash inflows from its project for years 1 through 8 are the same at $35,000. Mulligan has a discount rate of 12%. Because there is a shortage of funds to finance all good projects, Mulligan wants to compute the profitability index (PI) for each project. That way Mulligan can get an idea as to which project might be a better choice. What is the PI for Mulligan's current project?
A) About 1.24
B) About 1.21
C) About 1.19
D) About 1.09

Question

Quizplus · Accepted Answer

To calculate profitability index, we divide the present value of cash inflows by the initial outlay:

PV of cash inflows = $35,000 x ((1 - 1/(1+0.12)^8)/0.12) = $205,558.26

PI = PV of cash inflows / Initial outlay = $205,558.26 / $140,000 = 1.47

Since the PI is greater than 1, this project would be a good investment for Mulligan. Therefore, the best choice for Mulligan would be to invest in this project.