9. Profitability index

Estimating the cash flow generated by $1 invested in a project

The profitability index (PI) is a capital budgeting tool that is defined as the present value of a projects cash inflows divided by the absolute value of its initial cash outflow. Consider this case:

Fuzzy Badger Transport Company is considering investing $3,225,000 in a project that is expected to generate the following net cash flows:

Year	Cash Flow
Year 1	$325,000
Year 2	$475,000
Year 3	$425,000
Year 4	$475,000

Fuzzy Badger Transport Company uses a WACC of 10% when evaluating proposed capital budgeting projects. Based on these cash flows, determine this projects PI (rounded to four decimal places):

0.4955

0.4129

0.4335

0.4748

Fuzzy Badger Transport Companys 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 NPV of this project is ________ . On the basis of this evaluation criterion, Fuzzy Badger Transport Company should_______ in the project because the project _______ increase the firms value.

A project with a negative NPV will have a PI that is ________; when it has a PI of 1.0, it will have an NPV ________ .