The Profitability Index (PI) is calculated by dividing the present value (PV) of the future cash inflows by the initial investment. The future cash inflows are an annuity of $200,000 for five years. The present value of an annuity factor for 5 years at a 12% discount rate is calculated as [1 - (1 + r)^-n] / r, which is [1 - (1.12)^-5] / 0.12 ≈ 3.605.

The PV of the cash inflows is $200,000 × 3.605 = $721,000.

The PI is then calculated as:

PI = PV of Future Cash Flows / Initial Investment

PI = $721,000 / $600,000 ≈ 1.2017.

Rounded to one decimal place, the PI is 1.2.

1. Brealey

R. A.

Myers

S. C.

& Allen

F. (2020). Principles of Corporate Finance (13th ed.). McGraw-Hill Education. In Chapter 5

Section 5-3

the Profitability Index is defined as the ratio of a project's net present value to its initial investment

often expressed as PI = PV / Investment.

2. Ross

S. A.

Westerfield

R. W.

& Jaffe

J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education. Chapter 7

"Net Present Value and Other Investment Rules

" describes the Profitability Index rule and its calculation as the present value of future cash flows divided by the initial investment.

3. Horngren

C. T.

Datar

S. M.

& Rajan

M. V. (2015). Cost Accounting: A Managerial Emphasis (15th ed.). Pearson. Chapter 21

"Capital Budgeting and Cost Analysis

" details discounted cash flow (DCF) methods

including the formulas for calculating the present value of an annuity

which is essential for determining the PV of future cash inflows in this problem.

4. MIT OpenCourseWare. (2008). 15.401 Finance Theory I

Lecture Notes

Lecture 3: Valuing Projects and Firms. Massachusetts Institute of Technology. The lecture notes define the Profitability Index as PV(Cash Flows) / Initial Investment and discuss its application in capital rationing scenarios.