Profitability Index (PI)

Correct Answer: Reject the project as it indicates negative return on investment

In project selection, the Profitability Index (PI) measures the ratio of present value of future cash flows to the initial investment. A PI value of 1.0 is the breakeven point. When PI is less than 1.0, it indicates that the present value of future cash flows is less than the initial investment cost. A PI between 0.8 and 0.9 shows that the project will return only 80-90% of the invested capital, resulting in a loss. This makes accepting such a project financially unsound. The correct answer is to reject the project as it indicates negative return on investment. The other answers are incorrect because: - A PI below 1.0 never indicates potential for break-even - PI values below 1.0 do not indicate minimal investment risk; they actually indicate guaranteed losses - Future cash flows would be negative in present value terms, so further evaluation would be unnecessary and wasteful of resources.

Correct Answer: The project requires less initial capital investment to achieve the same NPV

The Profitability Index (PI) is calculated by dividing the present value of future cash flows by the initial investment. When two projects have identical NPVs, a higher PI indicates that one project achieves the same NPV with a smaller initial investment. This is significant because: - It shows better capital efficiency - It indicates lower upfront resource requirements - It suggests better return per dollar invested The other options are incorrect because: - Long-term sustainability and operational efficiency are not measured by PI - Consistency of cash flows is related to risk assessment, not PI calculations - Strategic alignment and stakeholder expectations are not measured through PI PI specifically measures the present value of future cash flows per unit of investment, making it an excellent tool for comparing capital efficiency between projects with equal NPVs.

Correct Answer: Projects with PI > 1 create value, and higher PI values indicate better investment opportunities

Profitability Index (PI) is a valuable metric for evaluating investment opportunities, where: Key points about PI: - PI = Present Value of Future Cash Flows / Initial Investment - PI measures value created per unit of investment - A PI greater than 1 indicates the project creates value - Higher PI values indicate greater returns relative to investment The correct answer accurately states two critical aspects of PI: 1. Projects with PI > 1 create value (as benefits exceed costs) 2. Higher PI values indicate better investment opportunities (more value per unit invested) Why other options are incorrect: - PI = 1 only indicates break-even, not maximum value - Lower PI values actually indicate less value creation, not more stability - PI values are crucial for project selection as they measure relative value creation For business analysts, understanding PI helps in making data-driven investment recommendations and prioritizing projects effectively.