Year Cash Flow 0 8900 1 2500 2 3600 3 3000 Required a What

Year Cash Flow 0 ?$8,900 1 2,500 2 3,600 3 3,000 Required : (a) What is the profitability index for the cashflows if the relevant discount rate is 7 percent? (b) What is the profitability index for the cashflows if the relevant discount rate is 16 percent? (c) What is the profitability index for the cashflows if the relevant discount rate is 25 percent?

Solution

Profitability Index = (PV of future cash flows) ÷ Initial investment

CF 1 = $2500

CF2 = $3600

CF3 = $3000

INVESTMENT = $8900

A)

present value = 1/(1.07) × 2500 + 1/(1.07)²× 3600 + 1/(1.07)³×3000

= 7929.7216

PI = 7929.7216/8900 = 0.8909

B)

Presemt value at 16%

= 1/(1.16) × 2400 + 1/(1.16)²×3600 + 1/(1.16)³×3000

=6752.53

PI = 6752.53/8900 = 0.7587

C)

present value at 25%

= 1/(1.25) × 2500 + 1/(1.25)²×3600 + 1/(1.25)³×3000

= $5840

PI = 5840/8900 = 0.6562