Please conclude this into 1 or 2 paragraphs by the meaning of 0.94 Probability Index.

Solution

Calculation of Profitability index(PI)

PI=Present value of future cash flow/Initial cost

In the given case,discount rate is not given but the NPV is given.With the help of NPV,we can determine the present value of future cash flow.

NPV=Present value of future cash flow-Initial cost

-$35039.79=Present value of future cash flow-$570,000

Present value of future cash flow=$570,000-$35039.79

=$534,960.21

PI=$534,960.21/$570,000

=0.94

Year 0 1 2 3 4 Machinery purchase cost Shipping cost Installation charge Total cost 500000 20000 30000 550000 Working capital requirement 20,000 200,000 4 800000 200,000 4.2 840000 200,000 4.41 882000 200,000 4.63 926100 Unit sales Selling price Sales Less: Costs Variable and fixed costs Opportunity cost related with frozen green juice Interest expense Depreciation Opportunity cost of lease rental 636725 15000 60000 600000 15000 60000 220000 10000 612000 15000 60000 165000 10000 624240 15000 60000 110000 10000 55000 10000 Total costs Net income before tax Less: Tax@30% Net income Add: Depreciation Operating cash flow 70000 -70000 21000 -49000 905000 -105000 31500 -73500 220000 146500 862000 -22000 6600 -15400 165000 149600 819240 62760 18828 43932 110000 153932 706724.8 219375.2 65812.56 153562.64 55000 208562.64 -49000 0 1 2 3 4 -570,000 -49000 -10000 146500 149600 Calculation of free cash flows Year Initial cost Operating cash flow Bond Release of working capital Salvage value Free cash flow 153932 208562.64 10000 20,000 28000 256,563 -570,000 146500 149600 153932 550000 NPV IRR -35039.79 8.34% Calculation of payback period Year cash flow cumulative cash flow 0 -570,000 -570,000 1 146500 -423,500 2 149600 -273,900 3 153932 -119,968 4 256,563 136,595 Payback period 3.467597