Landau Spandex Inc. ranks investments by using the profitability index (PI). The following data relate to Product A and Product B: $\begin{array} { l r r }
& \text { Product A } & \text { Product B } \
\text { Initial investment } & \$ 900,000 & \$ 1,500,000 \
\text { Present value of inflows } & 800,000 & 2,000,000
\end{array}$ Which Product would be more attractive as judged by its ranking, and why?

Question

Landau Spandex Inc. ranks investments by using the profitability index (PI). The following data relate to Product A and Product B: $\begin{array} { l r r } 
& \text { Product A } & \text { Product B } \
\text { Initial investment } & \$ 900,000 & \$ 1,500,000 \
\text { Present value of inflows } & 800,000 & 2,000,000
\end{array}$ Which Product would be more attractive as judged by its ranking, and why?

Quizplus · Accepted Answer

The profitability index (PI) determines the ratio of the present value of cash inflows to the initial investment. Thus, for Product A:

PI = (PV of inflows) / (Initial investment) = 800,000 / 900,000 = 0.89

For Product B:

PI = (PV of inflows) / (Initial investment) = 2,000,000 / 1,500,000 = 1.33

The higher the PI, the more attractive the investment. Thus, Product B is the better choice because it has a higher PI of 1.33, indicating that for every dollar invested, it generates $1.33 in present value of cash inflows.

Landau Spandex Inc Which Product Would Be More Attractive as Judged by Its