Snaptile Company evaluates future projects by using the profitability index. The company is currently reviewing three projects similar in nature and must choose one of the following: $\begin{array} { l l l r }
\text { Project } & \text { Initial Investment } && \begin{array} { l }
\text { Present Value of Cash } \
\text { Inflows }
\end{array} \
1 & \$ 400,000 && \$ 300,000 \
2 & 200,000 & & 320,000 \
3 & 350,000 & & 430,000
\end{array}$ Which project should Snaptile select if the decision is based entirely on the profitability index?

Question

Snaptile Company evaluates future projects by using the profitability index. The company is currently reviewing three projects similar in nature and must choose one of the following: $\begin{array} { l l l r } 
\text { Project } & \text { Initial Investment } && \begin{array} { l } 
\text { Present Value of Cash } \
\text { Inflows }
\end{array} \
1 & \$ 400,000 && \$ 300,000 \
2 & 200,000 & & 320,000 \
3 & 350,000 & & 430,000
\end{array}$ Which project should Snaptile select if the decision is based entirely on the profitability index?

Quizplus · Accepted Answer

The profitability index is calculated as the present value of cash inflows divided by the initial investment. Using this formula, we get the following profitability indices for each project:

Project 1: 300,000/400,000 = 0.75
Project 2: 320,000/200,000 = 1.60
Project 3: 430,000/350,000 = 1.23

Based on these results, project 2 has the highest profitability index and should be chosen. Therefore, the answer is (C).

Snaptile Company Evaluates Future Projects by Using the Profitability Index