How is the profitability index (PI) related to the NPV method? What do
QUESTION
How is the profitability index (PI) related to the NPV method? What does the PI measure?
mutually exclusive projects when evaluated on the basis of Net Present Value and profitability index. For example if the Present Value of cash inflows for two projects A and B is $ 10,000 and $ 20,000 with the initial outflow of $ 5,000 and $ 10,000 respectively. The profitability index for both the project is 2 but the net present value of project A is $ 5,000 while that of project B is $ 10,000. As per the profitability index any of the projects can be selected whereas as per the net present value criteria project B with higher net present value should be accepted.
ANSWER:
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