Berra, Inc. is currently considering an eight-year project that has an initial outlay or cost of $120,000. The future cash inflows from its project for years 1 through 8 are the same at $30,000. Berra has a discount rate of 11%. Because of capital rationing (shortage of funds for financing), Berra wants to compute the profitability index (PI) for each project. What is the PI for Berra's current project?
A) About 1.29
B) About 1.31
C) About 1.33
D) About 1.39

Question

Quizplus · Accepted Answer

The profitability index (PI) is calculated as the present value of future cash inflows divided by the initial investment. Using the discount rate of 11%, the present value of the annuity of $30,000 for 8 years is approximately $154,800. The PI is then $154,800 / $120,000 = 1.29.