7 . Profitability index Estimating the cash flow generated by $ 1 invested in investment The profitability
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Profitability index
Estimating the cash flow generated by $ invested in investment
The profitability index PI is a capital budgeting tool that provides another way to compare a projects benefits and costs. It is computed as a ratio of the discounted value of the net cash flows expected to be generated by a project over its life the projects expected benefits to its net cost NINV A projects PI value can be interpreted to indicate a projects discounted return generated by each dollar of net investment required to generate those returns.
Fuzzy Badger Transport Company is considering investing $ in a project that is expected to generate the following net cash flows:
Year
Cash Flow
Year $
Year $
Year $
Year $
Fuzzy Badger uses a WACC of when evaluating proposed capital budgeting projects. Based on these cash flows, determine this projects PI rounded to four decimal places
Fuzzy Badgers decision to accept or reject this project is independent of its decisions on other projects. Based on the projects PI the firm should the project.
By comparison, the net present value NPV of this project is On the basis of this evaluation criterion, Fuzzy Badger should in the project because the project increase the firms value.
When a project has a PI greater than it will exhibit an NPV ; when it has a PI of it will have an NPV equal to $ Projects with PIs will exhibit negative NPVs
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