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

Birdman, Inc. is currently considering an eight-year project that has an initial outlay or cost of $80,000. The future cash inflows from its project for years 1 through 8 are the same at $30,000. Birdman has a discount rate of 13%.

Because of concerns about funds being short to finance all good projects, Birdman wants to compute the profitability index (PI) for each project. What is the PI for Birdman’s current project?
A) About 1.50
B) About 1.60
C) About 1.70
D) About 1.80

ANSWER

Answer: D
Explanation: D) The PI is (NPV plus the absolute value of the costs) divided by the absolute value of the costs (or the present value of all future cash flows divided by the cost). The future after-tax cash inflows are an annuity. Thus, we can use:
NPV = -CF0 + . Inserting in the given values gives:
NPV = -$80,000 + = -$80,000 + ($30,000 × 4.798770)
= -$80,000 + $143,963.11 = $63,963.11. We can now compute the PI.

We have: PI = = = 1.7995, or about 1.80.