Based on the profitability index (PI) rule, should a project with the following cash flows be accepted if the discount rate is 8%? Why or why not? $$\begin{array} { c c }
\underline{\text { Year }} &\underline{ \text { Cash Flow }} \
0 & - \$ 18,600 \
1 & \$ 10,000 \
2 & \$ 7,300 \
3 & \$3,700
\end{array}$$
A)yes; because the PI is 1.008.
B)yes; because the PI is .992.
C)yes; because the PI is .999.
D)no; because the PI is 1.008.
E)no; because the PI is .992.

Question

Based on the profitability index (PI) rule, should a project with the following cash flows be accepted if the discount rate is 8%? Why or why not? $$\begin{array} { c c } 
\underline{\text { Year }} &\underline{ \text { Cash Flow }} \
 0 & - \$ 18,600 \
1 & \$ 10,000 \
2 & \$ 7,300 \
3 & \$3,700
\end{array}$$
A)yes; because the PI is 1.008.
B)yes; because the PI is .992.
C)yes; because the PI is .999.
D)no; because the PI is 1.008.
E)no; because the PI is .992.

Quizplus · Accepted Answer

To calculate the profitability index (PI) we divide the present value of future cash flows by the initial investment.

The present value of cash flows can be calculated using the following formula:

PV = CF1 / (1+r)^1 + CF2 / (1+r)^2 + CF3 / (1+r)^3

PV = 10,000 / (1+0.08)^1 + 7,300 / (1+0.08)^2 + 3,700 / (1+0.08)^3

PV = 10,000 / 1.08 + 7,300 / 1.1664 + 3,700 / 1.2597

PV = 9,259.26

Therefore, the PI = PV / Initial Investment = 9,259.26 / 18,600 = 0.497.

Since the PI is less than 1, the project should not be accepted. Thus, the correct answer is E.

Based on the Profitability Index (PI) Rule, Should a Project