University of Central Florida (UCF) FIN3403 Business Finance Practice Exam 3

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What is the decision rule for the profitability index (PI)?

Accept if PI is less than 1

Accept if PI is equal to 1

Accept if PI is greater than or equal to 1

The profitability index (PI) is a financial metric used to evaluate the attractiveness of an investment. It is calculated by dividing the present value of future cash flows by the initial investment cost. The decision rule for the PI is based on its relation to 1.

When the PI is greater than or equal to 1, it indicates that the present value of future cash flows is greater than or equal to the initial investment. This means that the investment is expected to generate returns that are at least equal to the cost, which suggests that it is worth undertaking. A PI greater than 1 signifies that the investment will add value to the firm, while a PI of exactly 1 indicates that the investment is breakeven in terms of value created.

Thus, the correct decision rule is to accept investment projects with a PI that is greater than or equal to 1, ensuring that resources are allocated to projects with positive or neutral net present value.

Accept if PI is greater than 0