9. Profitability index Estimating the cash flow generated by $1invested in a project The profitability index (PI) is a capitalbudgeting tool that is defined as the present value of a project’scash inflows divided by the absolute value of its initial cashoutflow. Consider this case: Happy Dog Soap Company is consideringinvesting $2,750,000 in a project that is expected to generate thefollowing net cash flows: Year Cash Flow Year 1 $275,000 Year 2$500,000 Year 3 $475,000 Year 4 $475,000 Happy Dog Soap Companyuses a WACC of 8% when evaluating proposed capital budgetingprojects. Based on these cash flows, determine this project’s PI(rounded to four decimal places): 0.4869 0.5125 0.5638 0.4613 HappyDog Soap Company’s decision to accept or reject this project isindependent of its decisions on other projects. Based on theproject’s PI, the firm should (ACCEPT or REJECT) the project? Bycomparison, the NPV of this project is (-$1,340,491, -$1,608,589,or -$1,072,343)?. On the basis of this evaluation criterion, HappyDog Soap Company should INVEST or NOT INVEST in the project becausethe project WILL or WILL NOT increase the firm’s value.
