What does a profitability index (PI) greater than 1 indicate?

What does a profitability index (PI) greater than 1 indicate?

• A. Positive NPV
• B. Negative NPV
• C. NPV zero
• D. IRR exceeds required rate

Answer: (A)

A profitability index above 1 shows the project is value-creating at the chosen discount rate. The PI is the present value of expected cash inflows divided by the initial investment. If this ratio exceeds 1, the present value of inflows is greater than the cost, which means the net present value (NPV) is positive, since NPV = PV inflows − initial investment. A positive NPV indicates the project adds value to the firm and is favorable at the required rate of return. The other outcomes would occur if inflows were equal to or less than the cost, and while an IRR above the required rate can accompany a PI > 1, the direct implication of PI > 1 is positive NPV.

A profitability index above 1 shows the project is value-creating at the chosen discount rate. The PI is the present value of expected cash inflows divided by the initial investment. If this ratio exceeds 1, the present value of inflows is greater than the cost, which means the net present value (NPV) is positive, since NPV = PV inflows − initial investment. A positive NPV indicates the project adds value to the firm and is favorable at the required rate of return. The other outcomes would occur if inflows were equal to or less than the cost, and while an IRR above the required rate can accompany a PI > 1, the direct implication of PI > 1 is positive NPV.