Consider a project with the following cash flows

What is the profitability index for the project?

Given the cash flows and discount rate, what is the profitability index closest to?

Profitability Index Calculation

The profitability index (PI) is an investment assessment ratio that compares the present value of future cash flows to the initial investment amount. The formula for calculating the profitability index is:

PI = PV of Future Cash Flows / Initial Investment

For the project with the given cash flows:

Initial Investment = $9,000

Sum of PV of Future Cash Flows = $292.93

Plugging the values into the formula:

PI = 292.93 / 9000 = 0.03255 or 3.26%

Therefore, the profitability index for the project is approximately 3.26%.

The profitability index is a crucial metric in evaluating the potential profitability of an investment project. In this case, the project with cash flows of -$9,000 in the first year and $3,600 in the subsequent years has a profitability index of approximately 3.26%. This indicates that for every dollar invested, the project is expected to generate a return of 3.26 cents.

A profitability index greater than 1 indicates that the project is expected to be profitable, while a value less than 1 suggests that the project may not be worthwhile. In this scenario, the profitability index of 3.26% suggests that the project is expected to be profitable, making it a potentially attractive investment opportunity.

It is important for investors and decision-makers to consider the profitability index alongside other financial metrics to make informed investment decisions. By calculating the profitability index, stakeholders can assess the value and viability of a project and determine whether it aligns with their investment objectives.