Question

The following information is available for a potential investment for Panda Company: Initial investment $95,000 Net annual cash inflow 20,000 Net present value 36,224 Salvage value 10,000 Useful life 10 yrs. The potential investment's profitability index is.
a.2.62.
b.3.22.
c.4.75.
d.1.38.

Answer 1

Answer:

d. 1.38

Explanation:

The computation of potential investment's profitability index is shown below:-

As we know that

Profitability index (PI) = PV of future cash flows ÷ Initial investment

Now

NPV = Present value of future cash flows - initial investment

$36,224 = Present value of future cash flows - $95,000

Present value of future cash flows = $36,224 + $95,000

= $131,224

So,

Profitability index = Present value of future cash flows ÷ Initial investment

= $131,224 ÷ $95,000

= 1.38

Therefore we have applied the above formula.

Answer 2

The potential investment's profitability index is 1.38.

The profitability index is used to determined the profitability of a project. It is a capital budgeting method

Profitability index = 1 + (NPV / Initial investment)

The net present value is the cost of an asset less the sum of the discounted cash flows of the project.

Profitability index = 1 + (36,224 / 95,000) = 1.38

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