A 25- year project has a cost of $1,500,000 and has annual cash flows of $400,000 in years 1-15, and $200,000 in years 16-25. The company's required rate is 14%. Given this information, calculate the profitability index of the project.
A) 1.74
B) 1.50
C) 1.25
D) 1.00
E) 0.75

Question

Quizplus · Accepted Answer

The profitability index (PI) is calculated by dividing the present value (PV) of future cash flows by the initial investment. First, calculate the PV of cash flows for years 1-15 and 16-25 separately using the formula PV = Cash Flow / (1 + r)^n, where r is the discount rate (14% or 0.14) and n is the year. Then, sum these PVs and divide by the initial investment of $1,500,000. The calculation shows a PI greater than 1, indicating the project generates a return exceeding the cost, with the correct answer being closest to 1.74 when calculated accurately.

A 25- Year Project Has a Cost of $1,500,000 and Has