In capital budgeting, the profitability index (PI) decision model is best used to
A) Evaluate mutually exclusive investments of different sizes.
B) Adjust for inflation in the net present value (NPV) calculation.
C) Select projects when capital budgeting funds are limited.
D) Adjust for risk in capital budgeting decisions.
E) Adjust for the difference between the accounting rate of return (ARR) and the internal rate of return (IRR).

Question

Quizplus · Accepted Answer

The profitability index (PI) decision model is used to select projects when capital budgeting funds are limited. It measures the present value of the expected future cash flows per dollar invested. Therefore, it helps to identify the projects that provide the highest return per dollar invested. This approach is especially useful in situations where the available capital budget is limited, and the company needs to prioritize among different investment opportunities. PI is calculated by dividing the present value of future cash flows by the initial investment. The project with the highest PI is preferred.

In Capital Budgeting, the Profitability Index (PI) Decision Model Is