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8. Profitability index Aa Aa Estimating the cash flow generated by $1 invested in investment The profitability index (PIis a capital budgeting tool that provides another way to compare a project's 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 project's expected benefits) to its net cost (NINV), A project's PI value can be interpreted to indicate a project's 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 $400,000 in a project that is expected to generate the following net cash flows Happy Doguses 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) Year Cash Flow $350,000 Year 1 Year 2 $475,000 O 3.0379 O 2.7003 Year 3 $425,000 Year 4 $425,000 O 3.7129 O 3.3754 Happy Dog's decision to accept or reject this project is independent of its decisions on other projects. Based on the project's PL, the firm shouid the project By comparison, the net present value (NPV) of this praject is criterion, Happy Dog should On the basis of this evaluation in the project because the project increase the firm's value. when it has a Pl of 1.00, it wil When a project has a P1 greater than 1 00, t will exhibit an NPV 1.00 wil exhibit negative NPVs have an NPV equal to s0, Protects with Pls