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Gold Mining, Inc
Gold Mining, Inc. is using the profitability index (PI) when evaluating projects. Gold Mining's cost of capital is 10.77 percent. What is the PI of a project if the initial costs are $2,182,275 and the project life is estimated as 6 years? The project will produce the same after-tax cash inflows of $442,241 per year at the end of the year. Round the answer to two decimal places. This set of problems is designed to be calculated using the Excel or financial calculator. Do not use financial tables to calculate these problems.
Expert Solution
Answer:
Summary:
Profitability index is the ratio between the sum of discounted cash inflow (after-tax) and initial investment.
Mathematically, profitability index is calculated as below:
Profitability Index = Sum of discounted Cash Inflows (after-tax) / Initial Investment
Profitability Index = 0.86
Please find the file attached below for calculation and explanations. Thank you.
Step-by-step explanation
Concept :
Profitability Index:
In certain cases we have to compare number of proposals each involving different amount of cash inflows. One of the method of comparing such proposal is to work out what is known as the Profitability Index or it is also known as 'Desirability Facto'. In other words, profitability index is the ratio between the sum of discounted cash inflow (after-tax) and initial investment.
Mathematically, profitability index is calculated as below:
Profitability Index = Sum of discounted Cash Inflows (after-tax) / Initial Investment
Decision Rule under profitability Index technique:
A project is acceptable if its profitability index value is greater than 1
A project is rejected if its profitability index value is less than 1
After understanding the about the profitability index, let me solve the above question below.
PFA
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