acob Inc. is considering a capital expansion project. The initial investment of undertaking this project is $188,500. This expansion project will last for five years. The net operating cash flows from the expansion project at the end of year 1, 2, 3, 4 and 5 are estimated to be $28,500, $38,780, $58,960, $77,680 and $95,380 respectively. Jacob has a weighted average cost of capital of 18%. Based on Jacob’s weighted average cost of capital, what is the profitability index (PI)of undertaking this project? That is, what is the profitability index if the weighted average cost of capital is used as the discount rate? Shall Jacob undertake the investment project?
Jacob Inc. is considering a capital expansion project. The initial investment of undertaking this project is $188,500. This expansion project will last for five years. The net operating cash flows from the expansion project at the end of year 1, 2, 3, 4 and 5 are estimated to be $28,500, $38,780, $58,960, $77,680 and $95,380 respectively.
Jacob has a weighted average cost of capital of 18%.
Based on Jacob’s weighted average cost of capital, what is the profitability index (PI)of undertaking this project? That is, what is the profitability index if the weighted average cost of capital is used as the discount rate? Shall Jacob undertake the investment project?
Profitability Index (PI) is calculated by dividing Present value of Cash flows by the initial investment. PI depicts the net present value per dollar of initial investment.
The formula for calculation of Profitability Index is as follows:
Initial Investment = $188500
WACC = Weighted Average Cost of capital =18%
n=Year
| Year | Nest Operating cash flow |
Present Value (PV)
|
| 1 | $28,500 | 24152.54237 |
| 2 | $38,780 | 27851.19219 |
| 3 | $58,960 | 35884.87625 |
| 4 | $77,680 | 40066.47982 |
| 5 | $95,380 | 41691.47704 |
| Total | 169646.5677 |
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