11. Profitability index Aa Aa 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: Free Spirit Industries is considering investing $2,225,000 in a project that is expected to generate the following net cash flows: Free Spirit Industries 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): Year Cash Flow Year1 $300,000 Year 2 $400,000 Year 3 $450,000 Year 4 $425,000 0.6235 O 0.6532 O 0.7126 O 0.5938 Free Spirit Industries'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 NPV of this project is Industries should On the basis of this evaluation criterion, Free Spirit in the project because the project increase the firm's value A project with a negative NPV will have a PI that is ; when it has a PI of 1.0, it will have an NPV