Answer (D) is correct . The profitability (excess present value) index facilitates the comparison of investments that have different initial costs. The profitability index equals the present value of future net cash inflows divided by the initial cash investment. The investment with the greater profitability index will be the preferred investment. However, if investments are mutually exclusive, the net present value method may be the better way of ranking projects. The excess present value index indicates the best return per dollar invested but does not consider the alternative possibilities for unused funds. Thus, the smaller of the mutually exclusive projects may have the higher index, but the incremental investment in the larger project may make it the better choice. For example, an $8,000,000 project may be a better use of funds than a combination of a $6,000,000 project with a higher index and the best alternative use of the remaining $2,000,000.
Answer (A) is incorrect because The investment generating cash flows the longest may not have the best return.
Answer (B) is incorrect because Given a net present value of zero (a profitability index exactly equal to one), the investor would be indifferent to the project.
Answer (C) is incorrect because The accounting rate of return is not a good measure of profitability. It ignores the time value of money.
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