Economics Capital Budgeting Questions Medium
The profitability index decision rule in capital budgeting is a financial metric used to evaluate the potential profitability of an investment project. It is calculated by dividing the present value of the project's future cash flows by the initial investment cost.
The profitability index decision rule states that if the profitability index is greater than 1, the project is considered profitable and should be accepted. Conversely, if the profitability index is less than 1, the project is deemed unprofitable and should be rejected.
The profitability index decision rule helps in comparing and ranking different investment projects by considering the relative profitability of each project. It allows decision-makers to prioritize projects with higher profitability indexes, as they are expected to generate higher returns relative to the initial investment. However, it is important to note that the profitability index should not be the sole criterion for decision-making, and other factors such as risk, strategic fit, and market conditions should also be considered.