The profitability index (PI) is a capital budgeting tool that is defined as the present value of
Question:
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:
Purple Whale Foodstuffs Inc. 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 | $425,000 |
Year 3 | $450,000 |
Year 4 | $400,000 |
Purple Whale Foodstuffs Inc. uses a WACC of 8% when evaluating proposed capital budgeting projects. Based on these cash flows, determine this project’s PI (rounded to four decimal places):
0.3878
0.4694
0.4898
0.4082
Purple Whale Foodstuffs Inc.’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, Purple Whale Foodstuffs Inc. should not invest in the project because the project ( ) increase the firm’s 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
Finite Mathematics and Its Applications
ISBN: 978-0134768632
12th edition
Authors: Larry J. Goldstein, David I. Schneider, Martha J. Siegel, Steven Hair