(Ignore income taxes in this problem.) The management of Edelmann Corporation is considering the following three investment projects: Rank the projects according to the profitability index, from most profitable to least profitable.

Question

(Ignore income taxes in this problem.) The management of Edelmann Corporation is considering the following three investment projects:  Rank the projects according to the profitability index, from most profitable to least profitable.

Quizplus · Accepted Answer

The profitability index (PI) is calculated as the present value of future cash flows divided by the initial investment.

PI for Project R = (1,000,000 + 900,000)/800,000 = 2.125
PI for Project S = (700,000 + 800,000)/600,000 = 2.5
PI for Project T = (600,000 + 500,000)/400,000 = 2.75

Thus, Project T has the highest profitability index, followed by Project S and then Project R. Therefore, the best choice is option C, which ranks the projects in order of increasing profitability index (S > T > R).

(Ignore Income Taxes in This Problem