Dakota,Inc.is currently considering an eight-year project that has an initial outlay or cost of $140,000.The cash inflows from its project for years 1 through 8 are the same at $35,000.Dakota has a discount rate of 12%.Because there is a shortage of funds to finance all good projects,Dakota wants to compute the profitability index (PI)for each project.That way Dakota can get an idea as to which project might be a better choice.What is the PI for Dakota's current project?

Question

Quizplus · Accepted Answer

To compute the profitability index (PI), we need to divide the present value of cash inflows by the initial outlay cost.

First, we need to calculate the present value of cash inflows for years 1 through 8 using the formula:
PV = CF/(1+r)^n
where PV is present value, CF is cash flow, r is discount rate, and n is the year of cash flow.

PV of cash inflows = $35,000/(1+0.12)^1 + $35,000/(1+0.12)^2 + ... + $35,000/(1+0.12)^8
PV of cash inflows = $246,689.04

Next, we can calculate the PI by dividing the PV of cash inflows by the initial outlay cost:
PI = PV of cash inflows / Initial outlay cost
PI = $246,689.04 / $140,000
PI = 1.76

Therefore, the PI for Dakota's current project is about 1.76, which is not one of the answer choices. However, if we divide 1 by the calculated PI, we can get the PI in terms of cost-benefit ratio, which is:

Cost-benefit ratio = 1 / PI
Cost-benefit ratio = 1 / 1.76
Cost-benefit ratio = 0.57

Now, we can compare the cost-benefit ratios of different projects to determine the best choice. A higher cost-benefit ratio indicates a better project. In this case, Dakota only has one project to compare with, so it is the best choice.

Answer: None
 Dakota only has one project to choose from, which is the current one with a PI of 1.76 (or a cost-benefit ratio of 0.57). Therefore, there are no other choices to compare with. Dakota should invest in the current project if it meets its strategic goals and objectives.