Calculate the Profitability index of a capital project. Theinitial investment is $250,000 for the purchase of some new radiologyequipment. The new equipment will save the organization $15,000 a yearfor the next 10 years. The project discount rate is 12%.

  • Determine the present value of the operating savings:
  • Present value of saving = savings per year X discounted rate

  • Determine the net present value (NPV)
  • Payclose attention here, this is where basic mathematical functions needto follow financial accounting theory. Hence, if we have a positivevalue for the present value of savings, we cannot have a negative NPV.We started with an initial investment amount, so start there aresubtract your net present value from that amount to determine your NPV.

    NPV=present value of savings – initial investment

  • Determine the profitability index
  • Profitability Index = NPV/initial investment

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