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9. Profitability index Aa Aa Estimating the cash flow generated by $1 invested in investment The profitability index (PI)is a capital budgeting tool that provides another way to compare a project's 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 project's expected benefits) to its net cost (NINV). A project's PI value can be interpreted to indicate a project's discounted return generated by each dollar of net investment required to generate those returns Consider the case of Purple Whale Foodstuffs Inc.: Purple Whale Foodstuffs Inc. is considering investing $500,000 in a project that is expected to generate the following net cash flows: Purple whaleuses a WACC of 996 when evaluating proposed capital budgeting projects. Based on these cash flows, determine this project's PI (rounded to four Year Cash Flow Year 1 $325,000 Year 2 $500,000 Year 3 $400,000 Year 4 $450,000 decimal places): O 2.289:3 O 2.9626 O 2.6933 O 2.1546 Purple Whale'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 net present value (NPV) of this project is criterion, Purple Whale should . On the basis of this evaluation in the project because the project increase the firm's value When a project has a PI greater than 1.00, it will exhibit an NPV have an NPV equal to $0. Projects with PIs ; when it has a PI of 1.00, it will 1.00 will exhibit negative NPVs

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