Profitability index = NPV / Investment cost

a.To illustrate the use of this measure, let us assume that Gardens Region Hospital is considering an investment in linen service shared with hospitals in the region.

The initial investment cost is $155,000 for the purchase of new equipment and light delivery trucks.

Savings in operating costs are estimated to be $35,000 per year for the entire 5-year life of the project.

If the discount rate is assumed to be 10%, the following calculations could be made, ignoring the effect of cost reimbursement and using the discount factors of Table 18-4.

b.The previous calculations give no consideration to the effects of cost reimbursement.

If we assume that 65% of the facilitys capital expenses are reimbursed and 50% of its operating expenses are reimbursed, then the following additional calculations must be made: