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Capital Invest has only $300,000 to invest, and Projects 2, 3 and 4 require more capital than the amount available.
Capital Invest has only $300,000 to invest, and Projects 3 and 4 require more capital than the amount available.
The Profitability Index represents the ratio of the benefits (net cash inflows) to the costs (net initial investment). Thus, it can identify the project with the greatest return per dollar of investment. The Profitability Index enables us to rank different sized investments, since the Profitability Index expresses profitability on a percentage basis rather than a total dollar amount basis. It is very useful for comparing multiple investments that are of different investment amounts. In this case, we can accept only one project because of the limitation in capital. The project with the highest Profitability Index is Project 3, even though it does not have the highest NPV or IRR. Although its NPV is lower than the NPV of Project 4, Project 3 requires only $248,000 of capital outlay compared with $272,000 required for Project 4. Presumably, if the company invests in Project 3, it would be able to find a liquid investment vehicle for the remaining $52,000 of available capital, and the combination of the two investments (Project 3 and the liquid investment) would result in a total return greater than the total return available by selecting Project 4 and combining it with a liquid investment of only $28,000.
No project with a negative NPV should be accepted, and Project 1 has a negative NPV.