Analysis using the profitability index:
A) frequently conflicts with the accept and reject decisions generated by the application of the net present value rule.
B) is useful as a decision tool when investment funds are limited.
C) cannot be used to aid capital rationing.
D) utilizes the same basic variables as those used in the average accounting return.
E) produces results which typically are difficult to comprehend or apply.

Question

Quizplus · Accepted Answer

The profitability index is useful as a decision tool when investment funds are limited, as it allows for a comparison of the return on investment for multiple projects with differing initial investments. This can be helpful in determining which projects to pursue when there is not enough capital to invest in all of them. Option A is incorrect because the profitability index and net present value rule should generally result in the same accept/reject decisions. Option C is incorrect because the profitability index can be used to aid capital rationing by ranking projects based on their return on investment per dollar invested. Option D is incorrect because the profitability index uses different variables than the average accounting return. Option E is incorrect because the results of the profitability index are typically easy to comprehend and apply.

Analysis Using the Profitability Index