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 projects 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 projects expected benefits) to its net cost (NINV). A projects PI value can be interpreted to indicate a projects 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 $600,000 in a project that is expected to generate the following net cash flows:

Year	Cash Flow
Year 1	$350,000
Year 2	$475,000
Year 3	$425,000
Year 4	$400,000

Happy Doguses a WACC of 7% when evaluating proposed capital budgeting projects. Based on these cash flows, determine this projects PI (rounded to four decimal places):

A) 1.9750

B) 2.2073

C) 2.5559

D) 2.3235

Happy Dogs decision to accept or reject this project is independent of its decisions on other projects. Based on the projects PI, the firm should ________(accept, reject) the project.

By comparison, the net present value (NPV) of this project is ___________($873,478: $754,367: $952,885: $635,257: -$194,071: $794,071) . On the basis of this evaluation criterion, Happy Dog should ________(invest, not invest) in the project because the project ________(will not, will) increase the firms value.

When a project has a PI greater than 1.00, it will exhibit an NPV ________(greater than $0, equal to $0, less than $0) ; when it has a PI of 1.00, it will have an NPV equal to $0. Projects with PIs ________(greater than, less than, equal to) 1.00 will exhibit negative NPVs.