4 terms

Profitability Index


Terms in this set (...)

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
Carlton Investment Proposal
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

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
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.

Calculate the Profitability Index
Profitability Index = .9643