Present value of an annuity of 1

periods 8% 9% 10%
1 0.926 0.917 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487

a company has a minimum required rate of return of 10%. it is considering investing in a project that costs $50,000 and is expected to generate cash inflows of $25,000 at the end of each year for three years. the profitability index for this project is

a.1.00.
b. 0.80.
c. 1.24.
d. 1.27.

The answer is c. 1.24.

Explanation:

Please find the below for explanation and calculation:

We have the formula Profitability Index = Present Value of all Future Cash  Flows discounted at required rate of return / Initial Investment Required.

Present value of the project is the present value of 3 annuities, $25,000 each year discounted at 10% per year which is calculated as: (25,000/0.1) x ( 1 - 1.1 ^(-3) ) = $62,171.230;

Initial Investment required is given at $50,000;

Thus Profitability index = Present Value of Future Cash Flows / Initial Investment Required. = $62,171.230/$50,000 = 1.24.

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