If the opportunity cost of capital is 12%, what is the profitability index for each project?

The following are the cash flows of two projects:

Year	Project A			Project B
0	−$	270		−$	270
1		150			170
2		150			170
3		150			170
4		150

If the opportunity cost of capital is 12%, what is the profitability index for each project?

 

Explanation


Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations.

NPVA = −$270 + [$150 × Annuity factor (0%, 4 periods)]

=  −$270+ $150   ×  [10.12 − 10.12 ×  1.12)4] =  $185.60
NPVB = −$200 + [$100 × Annuity factor (11%, 3 periods)]

=  −$270+ $170   ×  [10.12 − 10.12 ×  1.12)3] =  $138.31
The profitability indexes are as follows:
Project A: $185.60 / $270 = 0.687
Project B: $138.31 / $270 = 0.512

Profitability index = NPV / Initial investment

Thank you!