Allegra Company is considering the following three investment opportunities:
Project 1: Has an initial cost of $500,000 and the present value of its net cash inflows is $550,000.
Project 2: Has an initial cost of $450,000 and the present value of its net cash inflows is $504,000.
Project 3: Has an initial cost of $550,000 and the present value of its net cash inflows is $594,000.
Using the profitability index, rank the projects from most profitable to least profitable.

Question

Quizplus · Accepted Answer

The profitability index (PI) is calculated by dividing the present value of future cash inflows by the initial investment. For each project: Project 1 PI = $550,000 / $500,000 = 1.10, Project 2 PI = $504,000 / $450,000 = 1.12, Project 3 PI = $594,000 / $550,000 = 1.08. Thus, the ranking from most profitable to least profitable based on PI is Project 2, Project 1, Project 3.

Allegra Company Is Considering the Following Three Investment Opportunities