The following information is available for a potential investment for Panda Company: Initial investment $95,000 Net annual cash inflow 20,000 Net present value 36,224 Salvage value 10,000 Useful life 10 yrs. The potential investment's profitability index is. a.2.62.
b.3.22.
c.4.75.
d.1.38.

The potential investment's profitability index is 1.38.

The profitability index is used to determined the profitability of a project. It is a capital budgeting method

Profitability index = 1 + (NPV / Initial investment)

The net present value is the cost of an asset less the sum of the discounted cash flows of the project.

Profitability index = 1 + (36,224 / 95,000) = 1.38

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d. 1.38

Explanation:

The computation of potential investment's profitability index is shown below:-

As we know that

Profitability index (PI) = PV of future cash flows ÷ Initial investment

Now

NPV = Present value of future cash flows - initial investment

$36,224 = Present value of future cash flows - $95,000

Present value of future cash flows = $36,224 + $95,000

= $131,224

So,

Profitability index = Present value of future cash flows ÷ Initial investment

= $131,224 ÷ $95,000

= 1.38

Therefore we have applied the above formula.

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