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:

Purple Whale Foodstuffs Inc. is considering investing $$2,500,000$ in a project that is expected to generate the following net cash flows:

Year

Cash Flow

Year $1$ $$300,000$

Year $2$ $$500,000$

Year $3$ $$425,000$

Year $4$ $$450,000$

Purple Whale Foodstuffs Inc. uses a WACC of $9\%$ when evaluating proposed capital budgeting projects. Based on these cash flows, determine this project$$s PI $($rounded to four decimal places$)$:

$0\mathrm{.}5103$

$0\mathrm{.}5641$

$0\mathrm{.}0372$

$0\mathrm{.}5909$

$-$Purple Whale Foodstuffs Inc.$$s decision to accept or reject this project is independent of its decisions on other projects. Based on the project$$s PI$,$ the firm should $[$Reject or accept$]$ the project.

By comparison, the NPV of this project is $[-$$$1,099,113-$$$1,156,961-$$$925,569].$ On the basis of this evaluation criterion, Purple Whale Foodstuffs Inc. should $[$invest or not invest$]$ in the project because the project $[$will not or will$]$ increase the firm$$s value.

A project with a negative NPV will have a PI that is $[$equal$,$ greater, less than $1\mathrm{.}0]$ ; when it has a PI of $1\mathrm{.}0,$ it will have an NPV $[$greater$,$ equal, less than $$0].$