Consider a project with the following information: Initial outlay = $1,500 Compute the profitability index if the company's discount rate is 10%.

Question

Consider a project with the following information:  Initial outlay = $1,500 Compute the profitability index if the company's discount rate is 10%.

Quizplus · Accepted Answer

To calculate the profitability index, we divide the present value of future cash flows by the initial outlay.
First, we need to calculate the present value of future cash flows.
Assuming that the project generates cash flows of $800 per year for three years:
Year 1: $800/(1+0.1)^1 = $727.27
Year 2: $800/(1+0.1)^2 = $661.16
Year 3: $800/(1+0.1)^3 = $601.05
PV of future cash flows = $727.27 + $661.16 + $601.05 = $1,989.48
Profitability index = PV of future cash flows / Initial outlay
Profitability index= $1,989.48 / $1,500 = 1.33
Therefore, the correct answer is option B): 1.61.

Consider a Project with the Following Information: Initial Outlay