ABC Manufacturing has a project that requires an initial investment of $100 000 and has the following expected stream of cash flows:
$$\begin{array} { c c }
\text { Year } & \text { Annual cash flow } \
\hline 1 & \$ 80000 \
2 & \$ 60000 \
3 & \$ 20000
\end{array}$$
Assuming the company's cost of capital is 12 per cent,what is the profitability index for the project?

Question

ABC Manufacturing has a project that requires an initial investment of $100 000 and has the following expected stream of cash flows:
$$\begin{array} { c c } 
\text { Year } & \text { Annual cash flow } \
\hline 1 & \$ 80000 \
2 & \$ 60000 \
3 & \$ 20000
\end{array}$$
Assuming the company's cost of capital is 12 per cent,what is the profitability index for the project?

Quizplus · Accepted Answer

The profitability index (PI) is calculated by dividing the present value of future cash flows by the initial investment. First, calculate the present value (PV) of each cash flow using the formula PV = Cash Flow / (1 + r)^n, where r is the discount rate (12% or 0.12) and n is the year.For Year 1: PV = $80,000 / (1 + 0.12)^1 = $71,428.57For Year 2: PV = $60,000 / (1 + 0.12)^2 = $47,843.62For Year 3: PV = $20,000 / (1 + 0.12)^3 = $14,253.97Sum of PVs = $71,428.57 + $47,843.62 + $14,253.97 = $133,526.16Profitability Index = Sum of PVs / Initial Investment = $133,526.16 / $100,000 = 1.335

ABC Manufacturing Has a Project That Requires an Initial Investment Year Annual cash flow 1$800002$600003$20000\begin{array} { c c } \text { Year } & \text { Annual cash flow } \\\hline 1 & \$ 80000 \\2 & \$ 60000 \\3 & \$ 20000\end{array} Year 123​ Annual cash flow $80000$60000$20000​​

ABC Manufacturing Has a Project That Requires an Initial Investment $\begin{array} { c c } \text { Year } & \text { Annual cash flow } \\\hline 1 & \$ 80000 \\2 & \$ 60000 \\3 & \$ 20000\end{array}$