Capital rationing. TuleTime Comics is considering a new show that will generate annual cash flows of $100,000 into the infinite future. If the initial outlay for such a production is $1,500,000 and the appropriate discount rate is 6 per cent for the cash flows, then what is the profitability index for the project?
A) 0.11
B) 0.90
C) 1.11
D) 1.90

Question

Quizplus · Accepted Answer

The profitability index (PI) is calculated by dividing the present value of the future cash flows by the initial investment.

PV of future cash flows = $100,000 / 0.06 = $1,666,667

PI = $1,666,667 / $1,500,000 = 1.11

Since PI > 1, the project is considered acceptable under capital rationing. Therefore, the best choice is C.

Capital Rationing