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:

Free Spirit Industries Inc. is considering investing $2,500,000 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 | $425,000 |

Free Spirit Industries Inc. uses a WACC of 7% when evaluating proposed capital budgeting projects. Based on these cash flows, determine this project’s PI (rounded to four decimal places):

0.6286

0.5466

0.5193

0.6013

Free Spirit Industries 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 **(accept or
reject?)** the project.

By comparison, the NPV of this project is **(-1,133,486;
-1,360,183; or -906,789?)** . On the basis of this
evaluation criterion, Free Spirit Industries Inc. should
**(invest or not invest?)** in the project because the
project **(will or will not?)** increase the firm’s
value.

A project with a negative NPV will have a PI that is
**(greater than 1.0; equal to 1.0; or less than
1.0?)** ; when it has a PI of 1.0, it will have an NPV
**(equal to 0, less than 0, greater than 0?)** .

Answer #1

11. 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 project’s
cash inflows divided by the absolute value of its initial cash
outflow. Consider this case: Purple Whale Foodstuffs is considering
investing $3,225,000 in a project that is expected to generate the
following net cash flows: Year Cash Flow Year 1 $375,000 Year 2
$475,000 Year 3 $400,000...

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...

Profitability index
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...

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 project’s cash inflows divided by
the absolute value of its initial cash outflow. Consider this
case:
Purple Whale Foodstuffs Inc. is considering investing $2,225,000
in a project that is expected to generate the following net cash
flows:
Year
Cash Flow
Year 1
$350,000
Year 2
$400,000
Year 3...

Net present value (NPV)
Evaluating cash flows with the NPV method
The net present value (NPV) rule is considered one of the most
common and preferred criteria that generally lead to good
investment decisions.
Consider this case:
Suppose Hungry Whale Electronics is evaluating a proposed
capital budgeting project (project Alpha) that will require an
initial investment of $400,000. The project is expected to generate
the following net cash flows:
Year
Cash Flow
Year 1
$325,000
Year 2
$400,000
Year 3...

1. Net present value (NPV)
Evaluating cash flows with the NPV method
The net present value (NPV) rule is considered one of the most
common and preferred criteria that generally lead to good
investment decisions.
Consider this case:
Suppose Happy Dog Soap Company is evaluating a proposed capital
budgeting project (project Alpha) that will require an initial
investment of $450,000. The project is expected to generate the
following net cash flows:
Year
Cash Flow
Year 1
$375,000
Year 2
$425,000...

1. Net present value (NPV)
Evaluating cash flows with the NPV method
The net present value (NPV) rule is considered one of the most
common and preferred criteria that generally lead to good
investment decisions.
Consider this case:
Suppose Happy Dog Soap Company is evaluating a proposed capital
budgeting project (project Alpha) that will require an initial
investment of $400,000. The project is expected to generate the
following net cash flows:
Year
Cash Flow
Year 1
$375,000
Year 2
$400,000...

2. Net present value (NPV)
Evaluating cash flows with the NPV method
The net present value (NPV) rule is considered one of the most
common and preferred criteria that generally lead to good
investment decisions.
Consider the case of Lumbering Ox Truckmakers:
Suppose Lumbering Ox Truckmakers is evaluating a proposed
capital budgeting project (project Alpha) that will require an
initial investment of $400,000. The project is expected to generate
the following net cash flows:
Year
Cash Flow
Year 1
$375,000...

1. Net present value (NPV)
Evaluating cash flows with the NPV method
The net present value (NPV) rule is considered one of the most
common and preferred criteria that generally lead to good
investment decisions.
Consider this case:
Suppose Black Sheep Broadcasting Company is evaluating a
proposed capital budgeting project (project Alpha) that will
require an initial investment of $450,000. The project is expected
to generate the following net cash flows:
Year
Cash Flow
Year 1
$275,000
Year 2
$500,000...

Net present value (NPV)
Evaluating cash flows with the NPV method
The net present value (NPV) rule is considered one of the most
common and preferred criteria that generally lead to good
investment decisions.
Consider this case:
Suppose Happy Dog Soap Company is evaluating a proposed capital
budgeting project (project Alpha) that will require an initial
investment of $450,000. The project is expected to generate the
following net cash flows:
Year
Cash Flow
Year 1
$300,000
Year 2
$475,000
Year...

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