4 terms

What is the profitability index

Method of comparing alternative project that takes into account both size of the investment and it future net cash flows, its computed by dividing the present value net cash flow by the future index.

Formula for profitability index

(PV of future cash flows) ÷ Initial investment: This of course being where PV= the present value of the future cash flows in question.

Or = (NPV + Initial investment) ÷ Initial Investment

Or = (NPV + Initial investment) ÷ Initial Investment

Carlton Investment Proposal

A B C D

Investment required

$(85,500) $(203,000) $(93,000) $(172,000)

Present value of cash inflows

119,500 257,000 141,000 228,000

Net present value

$34,000 $54,000 $48,000 $56,000

Life of the project

5 years 7 years 6 years 6 years

Required:

Compute the project profitability index for each investment proposal

A B C D

Investment required

$(85,500) $(203,000) $(93,000) $(172,000)

Present value of cash inflows

119,500 257,000 141,000 228,000

Net present value

$34,000 $54,000 $48,000 $56,000

Life of the project

5 years 7 years 6 years 6 years

Required:

Compute the project profitability index for each investment proposal

Profitability index for Proposal A = 1.40

Profitability index for Proposal B = 1.27

Profitability index for Proposal C = 1.52

Profitability index for Project D = 1.33

Profitability index for Proposal B = 1.27

Profitability index for Proposal C = 1.52

Profitability index for Project D = 1.33

Julie Miller is evaluating a new project for her firm, Basket Wonders (BW). She has determined that the after-tax cash flows for the project will be $10,000; $12,000; $15,000; $10,000; and $7,000, respectively, for each of the Years 1 through 5. The initial cash outlay will be $40,000.

Required:

Calculate the Profitability Index

Required:

Calculate the Profitability Index

Profitability Index = .9643