Wakefield Company management evaluates future projects based on their profitability index. The company is currently reviewing five similar projects and must choose one project. Pertinent information regarding the projects is as follows.
Which project should Wakefield Company select if the decision is based entirely on profitability index?

Question

Wakefield Company management evaluates future projects based on their profitability index. The company is currently reviewing five similar projects and must choose one project. Pertinent information regarding the projects is as follows. 
Which project should Wakefield Company select if the decision is based entirely on profitability index?

Quizplus · Accepted Answer

The profitability index (PI) is calculated as the present value of cash inflows divided by the initial investment. Therefore, to maximize the profitability index, the project with the highest present value of cash inflows per dollar invested should be chosen. Project 4 has the highest profitability index of 1.22, indicating that for every dollar invested, the project will generate a present value of $1.22 in cash inflows. Therefore, Wakefield Company should select project 4.

Wakefield Company Management Evaluates Future Projects Based on Their Profitability