Smith Corporation
Smith Corporation is involved in the evaluation of a new computer-integrated manufacturing system.The system has a projected initial cost of $1,000,000.It has an expected life of six years,with no salvage value,and is expected to generate annual cost savings of $250,000.Based on Smith Corporation's analysis,the project has a net present value of $57,625.
Refer to Smith Corporation.What is the project's profitability index?

Question

Quizplus · Accepted Answer

The profitability index (PI) is calculated by dividing the present value of the expected cash inflows by the initial investment. 
PI = Present value of cash inflows / Initial investment

Using the given information, we can calculate the present value of the expected cash inflows as follows:

Annual cost savings = $250,000
Discount rate = not specified, assume 10%
Number of years = 6

Present value of cash inflows = $250,000 * [(1 - (1 + 0.10)^-6) / 0.10] = $1,185,129.46

The profitability index = $1,185,129.46 / $1,000,000 = 1.185

Therefore, the project's profitability index is 1.058 (rounded to three decimal places). A PI greater than 1 indicates that the project's cash inflows are greater than the initial investment, and therefore the project is expected to be profitable. Thus, based on the PI, Smith Corporation should proceed with the project.

Smith Corporation Smith Corporation Is Involved in the Evaluation of a New