{"id":269,"date":"2021-01-26T22:33:52","date_gmt":"2021-01-26T22:33:52","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/?post_type=chapter&#038;p=269"},"modified":"2021-08-13T16:09:39","modified_gmt":"2021-08-13T16:09:39","slug":"sensitivity-analysis-2","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/chapter\/sensitivity-analysis-2\/","title":{"raw":"Profitability Index","rendered":"Profitability Index"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Outcomes<\/h3>\r\n<ul>\r\n \t<li>Calculate the profitability index<\/li>\r\n<\/ul>\r\n<\/div>\r\nThe <strong>profitability index (PI)<\/strong> is a measure of a project's or investment's attractiveness. Compared to most calculations, the profitability index is a simple calculation:\r\n<p style=\"text-align: center;\">The present value of future expected cash flows<\/p>\r\n<p style=\"text-align: center;\">Divided by<\/p>\r\n<p style=\"text-align: center;\">The initial investment amount in the project.<\/p>\r\nFor the JuxtaPos project, the present value of future expected cash flows at 15% was:\r\n<div align=\"left\">\r\n<table class=\"fin-table acctstatement fw\">\r\n<thead>\r\n<tr class=\"u-sr-only\">\r\n<th scope=\"col\">Year<\/th>\r\n<th scope=\"col\">Factor<\/th>\r\n<th scope=\"col\">Amount<\/th>\r\n<th scope=\"col\">Total<\/th>\r\n<\/tr>\r\n<\/thead>\r\n<tbody>\r\n<tr>\r\n<td>Year 1<\/td>\r\n<td class=\"r\">$ \u00a0 \u00a060,000<\/td>\r\n<td class=\"r\">times the factor of\u00a0 \u00a0 0.8700<\/td>\r\n<td class=\"r\">= $52,200<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 2<\/td>\r\n<td class=\"r\">\u00a0 60,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 0.7560<\/td>\r\n<td class=\"r\">$ 45,360<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 3<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 55,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 0.6580<\/td>\r\n<td class=\"r\">$ 36,190<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 4<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 55,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 0.5720<\/td>\r\n<td class=\"r\">$ 31,460<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 5<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 50,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 0.4970<\/td>\r\n<td class=\"r\">$ 24,850<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Year 6<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 65,000<\/td>\r\n<td class=\"r\">\u00a0 \u00a0 0.4320<\/td>\r\n<td class=\"r\">$ 28,080<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Total present value of cash inflows<\/td>\r\n<td><\/td>\r\n<td><\/td>\r\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>$218,140<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\n&nbsp;\r\n\r\nThe initial investment was $230,000, so the PI is 218,140 \/ 230,000 = 0.95\r\n\r\nAs a general rule of thumb, a PI greater than 1.0 is deemed as a good investment, with higher values corresponding to more attractive projects. As we assess our capital needs and constraints as we compare various options, some of which are mutually exclusive, we would normally choose those with the highest PIs (absent other qualitative factors which have probably already been taken into account in the screening process).\r\n\r\nNow check your understanding of the profitability index.\r\n<div class=\"textbox tryit\">\r\n<h3>Practice Question<\/h3>\r\n[ohm_question hide_question_numbers=1]221586[\/ohm_question]\r\n\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Outcomes<\/h3>\n<ul>\n<li>Calculate the profitability index<\/li>\n<\/ul>\n<\/div>\n<p>The <strong>profitability index (PI)<\/strong> is a measure of a project&#8217;s or investment&#8217;s attractiveness. Compared to most calculations, the profitability index is a simple calculation:<\/p>\n<p style=\"text-align: center;\">The present value of future expected cash flows<\/p>\n<p style=\"text-align: center;\">Divided by<\/p>\n<p style=\"text-align: center;\">The initial investment amount in the project.<\/p>\n<p>For the JuxtaPos project, the present value of future expected cash flows at 15% was:<\/p>\n<div style=\"text-align: left;\">\n<table class=\"fin-table acctstatement fw\">\n<thead>\n<tr class=\"u-sr-only\">\n<th scope=\"col\">Year<\/th>\n<th scope=\"col\">Factor<\/th>\n<th scope=\"col\">Amount<\/th>\n<th scope=\"col\">Total<\/th>\n<\/tr>\n<\/thead>\n<tbody>\n<tr>\n<td>Year 1<\/td>\n<td class=\"r\">$ \u00a0 \u00a060,000<\/td>\n<td class=\"r\">times the factor of\u00a0 \u00a0 0.8700<\/td>\n<td class=\"r\">= $52,200<\/td>\n<\/tr>\n<tr>\n<td>Year 2<\/td>\n<td class=\"r\">\u00a0 60,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 0.7560<\/td>\n<td class=\"r\">$ 45,360<\/td>\n<\/tr>\n<tr>\n<td>Year 3<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 55,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 0.6580<\/td>\n<td class=\"r\">$ 36,190<\/td>\n<\/tr>\n<tr>\n<td>Year 4<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 55,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 0.5720<\/td>\n<td class=\"r\">$ 31,460<\/td>\n<\/tr>\n<tr>\n<td>Year 5<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 50,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 0.4970<\/td>\n<td class=\"r\">$ 24,850<\/td>\n<\/tr>\n<tr>\n<td>Year 6<\/td>\n<td class=\"r\">\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 65,000<\/td>\n<td class=\"r\">\u00a0 \u00a0 0.4320<\/td>\n<td class=\"r\">$ 28,080<\/td>\n<\/tr>\n<tr>\n<td>Total present value of cash inflows<\/td>\n<td><\/td>\n<td><\/td>\n<td class=\"r line-single\"><span class=\"u-sr-only\">Single Line<\/span>$218,140<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>&nbsp;<\/p>\n<p>The initial investment was $230,000, so the PI is 218,140 \/ 230,000 = 0.95<\/p>\n<p>As a general rule of thumb, a PI greater than 1.0 is deemed as a good investment, with higher values corresponding to more attractive projects. As we assess our capital needs and constraints as we compare various options, some of which are mutually exclusive, we would normally choose those with the highest PIs (absent other qualitative factors which have probably already been taken into account in the screening process).<\/p>\n<p>Now check your understanding of the profitability index.<\/p>\n<div class=\"textbox tryit\">\n<h3>Practice Question<\/h3>\n<p><iframe loading=\"lazy\" id=\"ohm221586\" class=\"resizable\" src=\"https:\/\/ohm.lumenlearning.com\/multiembedq.php?id=221586&theme=oea&iframe_resize_id=ohm221586\" width=\"100%\" height=\"150\"><\/iframe><\/p>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-269\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>Profitability Analysis. <strong>Authored by<\/strong>: Joseph Cooke. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":364389,"menu_order":18,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"Profitability Analysis\",\"author\":\"Joseph Cooke\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-269","chapter","type-chapter","status-publish","hentry"],"part":37,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/269","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/wp\/v2\/users\/364389"}],"version-history":[{"count":5,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/269\/revisions"}],"predecessor-version":[{"id":1899,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/269\/revisions\/1899"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/parts\/37"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapters\/269\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/wp\/v2\/media?parent=269"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=269"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/wp\/v2\/contributor?post=269"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-managerialaccounting\/wp-json\/wp\/v2\/license?post=269"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}