A company is considering a $2,000 investment in a project with the following predicted cash flows...

Question:

A company is considering a $2,000 investment in a project with the following predicted cash flows in the subsequent four years: $1,300, $950, $700, and $300. It required a 12% return.What is the profitability index for this investment and what does it suggest?

A. Because the profitability index is 1.30, the company should accept the opportunity

B. Because the profitability index is 1.30, the company should reject the opportunity

C. Because the profitability index is 1.24, the company should accept the opportunity

D. Because the profitabilty index is 1.24, the company should reject the opportunity

Profitability Index(P.I.):

It is a ratio of present value of cash inflows to present value of cash outflows. It is one of the approach to analyse capital budgeting decisions. When P.I. > 1, proposal is accepted. This is because, in that case, Present value of cash inflows is greater than that of outflows and there is a positive addition to the wealth of shareholders.

Answer and Explanation:

Statement A is correct.

Profitability Index= P.V. of cash inflows/ P.V. of cash outflows

  • P.v. of cash inflows= (1300/1.12) + (950/1.12^2) +...

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Net Present Value: Evaluating Estimates
Net Present Value: Evaluating Estimates

from Financial Accounting: Help and Review

Chapter 4 / Lesson 1
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