9. 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 by each dollar of net investment required to generate those returns. Consider the case of Happy Dog Soap Company: Happy Dog Soap Company is considering investing $400,000 in a project that is expected to generate the following net cash flows: Year Year 1 Year 2 Year 3 Cash Flow $300,000 $400,000 $450,000 Year 4 $425,000 Happy Dog 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). 3.1381 O 3.3033 2.9730 2.6426 Happy Dog'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 net present value (NPV) of this project is should in the project because the project On the basis of this evaluation criterion, Happy Dog increase the firm's value. when it has a PI of 1.00, it will have an NPV equal to $0. When a project has a PI greater than 1.00, it will exhibit an NPV Projects with PIs 1.00 will exhibit negative NPVs