Consider a project that costs $10,000 today. It will provide benefits of $4,000 at the end of...
Question:
Consider a project that costs $10,000 today. It will provide benefits of $4,000 at the end of Year 1, $3,500 at the end of Year 2, and $3,500 at the end of Year 3.
a) If the discount rate is 6%, will this project be approved using cost-benefit analysis?
b) Would your answer change if the discount rate is:
1) 5%,
2) 4%?
Cost-Benefit Analysis:
The cost-benefit analysis in capital budgeting is applied to appraise the profitability of a project. We compute the ratio of the present value of the future benefits to the present value of the costs. The costs represent the cash outflow while the benefits are the cash inflows the investor gains. A project having a cost-benefit ratio >1 is considered profitable and should be approved.
Answer and Explanation: 1
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View this answerCost = $10,000
Question a)
r =6%
Calculate the present value of the benefits
| Year | Cash flows | PVIF | PV |
|---|---|---|---|
| 1 | 4,000 | 0.9434 | 3,773.58 |
| 2 | ... |
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Profitability Index Method: Definition & Calculations
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Chapter 14 / Lesson 5
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The profitability index method measures the acceptability of a project through the ratio of the projected cash inflow to the initial investment. Learn about the definition and calculation of profitability index and understand how to interpret its results.
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