medium · Principles of Finance capital-budgeting
Under capital rationing, why might a firm use the 'Profitability Index' (PI) instead of just ranking by the highest absolute NPV?
- Ranking by NPV is always mathematically identical to ranking projects by PI.
- PI identifies the 'bang for the buck', maximizing total NPV within a limited budget.
- PI ignores the firm's cost of capital entirely, supposedly easing use in volatile markets.
- PI is simply a more precise way for analysts to estimate a project's true internal rate of return.
Sign up free to see the explanation and track your rank →
More Principles of Finance capital-budgeting practice
- Calculate the 'Profitability Index' for a project with an initial cost of 200,000 and a pr
- According to the Net Present Value criterion, which project should be chosen?
- If the required rate of return is 10%, what is the Net Present Value (NPV)?
- Which type of 'real option' is being exercised when a pharmaceutical company decides to bu
- If the cost of capital is 10%, what is the Net Present Value (NPV) of the project?
- A firm has FCFF of $100M, interest expense of $20M, a tax rate of 25%, and net new borrowi
- What is the Payback Period of the project?
- What is the Profitability Index (PI) and what does it indicate for capital rationing?