Use the following information to answer the following question.
Below are the expected after-tax cash flows for Projects Y and Z.Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.
Project Y Project Z

-WKW, Inc.is analyzing a project that requires an initial investment of $10,000, followed by cash inflows of $1000 in year 1, $4000 in year 2 and $15,000 in year 3.The cost of capital is 10%.What is the profitability index of the project?
A)1.04
B)1.55
C)1.78
D)1.97

Question

Use the following information to answer the following question.
Below are the expected after-tax cash flows for Projects Y and Z.Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.
Project Y Project Z
 
-WKW, Inc.is analyzing a project that requires an initial investment of $10,000, followed by cash inflows of $1000 in year 1, $4000 in year 2 and $15,000 in year 3.The cost of capital is 10%.What is the profitability index of the project?
A)1.04 
B)1.55 
C)1.78 
D)1.97

Quizplus · Accepted Answer

To calculate the profitability index, we need to divide the present value of future cash inflows by the initial investment.
PV of Year 1 cash inflow = $1000 / (1.10)^1 = $909.09
PV of Year 2 cash inflow = $4000 / (1.10)^2 = $3305.79
PV of Year 3 cash inflow = $15,000 / (1.10)^3 = $11157.02
Total PV of cash inflows = $909.09 + $3305.79 + $11157.02 = $15071.90
Profitability Index = Total PV of Cash Inflows / Initial Investment = $15071.90 / $10,000 = 1.507
Therefore, the best choice is B, with a profitability index of 1.55.

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