Answer (A) is correct . The profitability index is the ratio of the present value of future net cash inflows to the initial cash investment; that is, the figures are those used to calculate the net present value (NPV), but the numbers are divided rather than subtracted. This variation of the NPV method facilitates comparison of different-sized investments. It provides an optimal ranking in the absence of capital rationing.
Answer (B) is incorrect because The net present value method does not provide a return per dollar invested and is therefore not as effective as the profitability index in the absence of capital rationing.
Answer (C) is incorrect because The payback method gives no consideration to the time value of money or to returns after the payback period.
Answer (D) is incorrect because The profitability index method and the NPV method are discounted cash flow methods. However, the profitability index method is the variant that purports to calculate a return per dollar of investment.
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