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 Free Spirit Industries Inc.:

Free Spirit Industries Inc. is considering investing $450,000 in a project that is expected to generate the following net cash flows:

Year	Cash Flow
Year 1	$350,000
Year 2	$425,000
Year 3	$500,000
Year 4	$475,000

Free Spirit uses a WACC of 10% when evaluating proposed capital budgeting projects. Based on these cash flows, determine this projects PI (rounded to four decimal places).

2.8912

3.0434

2.5869

3.1956

Free Spirits 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 ######### . On the basis of this evaluation criterion, Free Spirit should (INVEST/NOT INVEST) in the project because the project (WILL/ WILL NOT) increase the firms value.

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