Using the cash flows described above, what is the profitability index (PI) with an initial investment of $2,000?

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Study for the Finance and Investment Challenge Test. Approaches include flashcards and multiple-choice questions with hints and explanations. Ready yourself to ace the exam!

Multiple Choice

Using the cash flows described above, what is the profitability index (PI) with an initial investment of $2,000?

Explanation:
The profitability index shows how much value, in present value terms, you get back for every dollar invested. It is calculated as the present value of expected cash inflows divided by the initial investment. In this scenario, discounting the future cash inflows gives a total present value of 1,882. Dividing by the initial outlay of 2,000 yields 0.941. That means about 0.94 dollars of value are returned for each dollar invested in present value terms. Because the index is less than 1, the project doesn’t cover its cost on a present-value basis. If the present value of inflows had been exactly 2,000, the PI would be 1 (break-even in PV terms); higher PV inflows would push the PI above 1, and lower PV inflows would push it further below 1.

The profitability index shows how much value, in present value terms, you get back for every dollar invested. It is calculated as the present value of expected cash inflows divided by the initial investment.

In this scenario, discounting the future cash inflows gives a total present value of 1,882. Dividing by the initial outlay of 2,000 yields 0.941. That means about 0.94 dollars of value are returned for each dollar invested in present value terms. Because the index is less than 1, the project doesn’t cover its cost on a present-value basis.

If the present value of inflows had been exactly 2,000, the PI would be 1 (break-even in PV terms); higher PV inflows would push the PI above 1, and lower PV inflows would push it further below 1.

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