Question

For independent projects with conventional cash flows, which of the following can we use as a requirement for the project to be accepted?

Multiple Choice

• PI greater than 1.0

• AAR lower than the required rate

• Payback period that exceeds the requirement

• Required discount rate greater than the IRR

• Discounted payback period less than the payback period

Answer 1

option a) PI greater than 1.0

Profitability index is defined as the ratio of the present value of all the cash inflows to the initial investment. As PI for the project increases, the attractiveness of the project also increases.Thus, PI greater than 1 means we have better cash in flows than the initial investment and hence the project is profitable.

For all other cases the project will be rejected.
AAR should be greater than the target or required rate to accept the project.
Payback period should be less than the requirement to accept the project
IRR should be greater than required discount rate to accept the project
Discounted payback period can never be less than the payback period as the present value of cash inflows is always lower than the absolute value, hence discounted payback period is always greater than the payback period.