CA Intermediate · Financial Management and Strategic Management · Investment Decisions
Sundaram Textiles is evaluating a project with an initial outlay of ₹5,00,000. The present value of its future cash inflows, discounted at the firm's cost of capital, is ₹6,25,000. The total undiscounted inflows are ₹7,50,000. What is the profitability index of the project?
The profitability index is 1.25. It is the present value of inflows, ₹6,25,000, divided by the initial outlay of ₹5,00,000. Undiscounted inflows must not be used, since the index is a discounted measure, and a value above 1 means the project should be accepted.
- A1.25Correct
- B0.80
- C0.25
- D1.50
Explanation
Profitability index = PV of cash inflows / PV of cash outflows = 6,25,000 / 5,00,000 = 1.25. The value 1.50 comes from using undiscounted inflows, which ignores the time value of money. The value 0.25 is only the net profitability index (NPV/outlay), and 0.80 inverts the ratio.
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