Dakota, Inc. is currently considering an eight-year project that has a

Dakota, Inc. is currently considering an eight-year project that has an initial outlay or cost of $140,000. The cash inflows from its project for years 1 through 8 are the same at $35,000. Dakota has a discount rate of 12%.

Because there is a shortage of funds to finance all good projects, Dakota wants to compute the profitability index (PI) for each project. That way Dakota can get an idea as to which project might be a better choice. What is the PI for Dakota’s current project?
A) About 1.24
B) About 1.21
C) About 1.19
D) About 1.09

ANSWER

Answer: A
Explanation: A) The PI is (NPV plus the absolute value of the costs) divided by the absolute value of the costs. The future after-tax cash inflows are an annuity. Thus, we can use:
NPV = -CF0 + . Inserting the given values gives:
NPV = -$140,000 + = -$140,000 + ($35,000 × 4.967640)
= -$140,000 + $173,867.39 = $33,867.39. We can now compute the PI.

We have: PI = = = 1.2419, or about 1.24.