Question

Calculating Profitability Index Bill plans to open a self serve grooming center in a storefront. The grooming equipment will cost $325,000, to be paid immediately. Bill expects after tax cash inflows of $67,000 annually for 7 years, after which he plans to scrap the equipment and retire to the beaches of Nevis. The first cash inflow occurs at the end of the first year. Assume the required return is 13 percent. What is the project’s PI? Should it be accepted?

Answer 1

Answer and Explanation:

The computation of the Pi is shown below:

As we know that

Profitability index = Present value of cash inflows ÷ Initial investment

where,

The Present value of cash inflows is

PVA = Periodic amount × (1 - (1 + interest rate) - time period ÷ interest rate)

= $67,000 × (1 - (1 + 13%) - 7 ÷ 13%)

= $67,000 × (1 - ( 1+ 0.13) - 7 ÷ 0.13)

= $67,000 × (1 - ( 1.13) -7 ÷ 0.13)

= $67,000 × (1 - 0.42506064374) ÷ 0.13)

= $67,000 × (0.57493935626 ÷ 0.13)

= $67000 × 4.422610432

= $296,314.90

Now the Profitability index is

= $296,314.90 ÷ $325,000

= 0.9117

As the PI is less than 1 so the project should not be accepted