Question

Initial Outlay $50 million Year 1 $10 million Year 2 $20 million Year 3 $20 million Year 4 $10 million Year 5 $5 million The required rate of return is 15%. What is the Profitability Index of project? Round to the second decimal place. Type only numbers without any unit ($,%, etc.)

Answer 1

Profitability index is calculated using the below formula:

Profitability Index= NPV + Initial investment/ Initial investment

Net present value is solved using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$50 million. It is entered has a negative value since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the required rate of return of 15%.
• Press the down arrow and CPT buttons to get the net present value.

Net Present value of cash flows at 15% required rate of return is is -$4.83 million.

Profitability Index= -$4.83 million + $50 million/ $50 million

                                   = $45.17 million/ $50 million

                                   = 0.9034 $\rightarrow$ 0.90.

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