Capital rationing. You are considering a project that has an initial cost of $1,200,000. If you take the project, it will produce net cash flows of $300,000 per year for the next six years. If the appropriate discount rate for the project is 10 per cent, what is the profitability index of the project?
A) 0.09
B) 1.09
C) 2.09
D) 2.18

Question

Quizplus · Accepted Answer

The profitability index (PI) is calculated as the present value of future cash flows divided by the initial investment. The present value of the cash flows is $300,000 * [(1 - (1 + 0.10)^-6) / 0.10] = $1,638,616. The PI is $1,638,616 / $1,200,000 = 1.09.

Capital Rationing