Profitability index

Estimating the cash flow generated by $$1$ invested

The profitability index $($PI$)$ is a capital budgeting tool that is defined as the present value of a project's cash inflows divided by the absolute value of its

initial cash outflow.

Consider this case:

Free Spirit Industries Inc. is considering investing $$600,000$ in a project that is expected to generate the following net cash flows:

Free Spirit Industries Inc. uses a WACC of $9\%$ when evaluating proposed capital budgeting projects. Based on these cash flows, determine this

project's PI:

$1\mathrm{.}9403$

$2\mathrm{.}2827$

$2\mathrm{.}1686$

$1\mathrm{.}8262$

Free Spirit Industries Inc.$\text{'}$s decision to accept or reject this project is independent of its decisions on other projects. Based on the project's PI$,$ the firm

should

the project.

By comparison, the NPV of this project is

$.$ On the basis of this evaluation criterion, Free Spirit Industries Inc. should

$\_$ in the project because the project

increase the firm's value.

When a project has a PI greater than $1\mathrm{.}0,$ it will exhibit an NPV

; when it has a PI of $1\mathrm{.}0,$ it will have an NPV equal to $$0.$