Question
Profitability Index as a capital budgeting method
Answer :
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Profitability Index (PI) is an important capital budgeting technique used to evaluate and rank investment proposals. It is also known as the Benefit-Cost Ratio. The method establishes a relationship between the present value of future cash inflows and the initial investment required for a project. It is particularly useful when a firm has limited funds and has to select the most profitable projects from several investment opportunities. The Profitability Index is calculated as: Profitability Index = Present Value of Future Cash Inflows ÷ Initial Investment The present value of future cash inflows is calculated by discounting the expected cash flows at the firm's required rate of return or cost of capital. If the project involves an initial investment at different points in time, the relevant present values of the investments are also considered. The decision rule under the Profitability Index method is straightforward. If the PI is
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