The profitability index (PI) is a capital budgeting tool that is defined as the present value of a projects cash inflows divided by the absolute value of its initial cash outflow. Consider this case:

Free Spirit Industries Inc. is considering investing $2,750,000 in a project that is expected to generate the following net cash flows:

Year Cash Flow

Year 1 $325,000

Year 2 $425,000

Year 3 $500,000

Year 4 $450,000

Free Spirit Industries Inc. uses a WACC of 9% when evaluating proposed capital budgeting projects. Based on these cash flows, determine this projects PI (rounded to four decimal places):

A. 0.5938 B. 0.4948 C. 0.5443 D. 0.5195

Free Spirit Industries Inc.s decision to accept or reject this project is independent of its decisions on other projects. Based on the projects PI, the firm should ______ the project.

A. Accept B. Reject

By comparison, the NPV of this project is ________ (-$1,389,238, -$1,111,390, $1,389,238) . On the basis of this evaluation criterion, Free Spirit Industries Inc. should ________ (invest/ not invest) in the project because the project _______ (will/ will not) increase the firms value.

A project with a negative NPV will have a PI that is ______(greater than 1, less than 1, equal to 1) when it has a PI of 1.0, it will have an NPV _____ (equal to $0, greater than $0, less than $0)