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 $2,750,000 in a project that is expected to generate the following net cash flows: Year Year 1 Year 2 Cash Flow $275,000 $475,000 $475,000 $450,000 Year 3 Year 4 Free Spirit Industries uses a WACC of 109 when evaluating proposed capital budgeting projects. Based on these cash Mows, determine this project's PI (rounded to four decimal places) 0.5227 0.4990 0.4752 0.4277 Free Spirit Industries's decision to accept or reject this project is independent of its decisions on other projects. Based on the project's Pr, the firm should the project On the basis of this evaluation criterion, Free Spirit Industries should in By com reject he NPV of this project is the pro accept use the project Increase the firm's value. A project with a negative NPV will have a Pt that is , when it has a PI of 1.0, it will have an NPV 0.4277 -$1,371,047 Free Spirit Industries's decision to accept-$1,443,207 Joject is Independent of its decisions on other projects. Based on the project's P1, the firm the project should -51,731,848 By comparison, the NPV of this project is the project because the project On the basis of this evaluation criterion, Free Spirit Industries should increase the firm's value A project with a negative NPV will have a PI that is when it has a PI of 10, it will have an NPV 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 the project. should By comparison, the NPV of this project is the project because the project On the basis of this evaluation criterion, Free Spirit Industries should Increase the firm's value, Invest when it has a Pl of 1.0, it will have an NPV not invest A project with a negative NPV will have a PI that is 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 less than 10 By comparison, the NPV of this project is equal to 10 basis of this evaluation criterion, Free Spirit Industries should the project because the project incred greater than 1.0 in A project with a negative NPV will have a Pl that is when it has a PI of 1.0, it will have an NPV Free Spirit Industries's decision to accept or reject this project is independent of its decisions on other projects. Based on the project's Pl, the firm should the project equal to $0 By comparison, the NPV of this project is On the basis of this evaluation criterion, Free Spirit Indusy greater than $0 the project because the project increase the firm's value. less than 50 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
