COST ACCOUNTING
CAPITAL BUDGETING
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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when the NPV method and the IRR method give conflicting signals on mutually exclusive projects
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in capital rationing situations
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when the cash flow pattern is unusual
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when project scales are of concern
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Detailed explanation-1: -The profitability index indicates whether an investment should create or destroy company value. It takes into consideration the time value of money and the risk of future cash flows through the cost of capital. It is useful for ranking and choosing between projects when capital is rationed.
Detailed explanation-2: -The profitability index is the net present value of the project income divided by the project cost. It provides a useful guide for comparing projects based on their expected return. The profitability index is considered to be one of the best financial tools to use in a capital rationing situation.
Detailed explanation-3: -The profitability index is used for comparison and contrast when a company has several investments and projects it is considering undertaking. The PI is especially useful when a company has limited resources and can’t pursue all potential projects, as it can be used to prioritize which projects to pursue first.
Detailed explanation-4: -Profitability Index is a capital budgeting tool used to rank projects based on their profitability. It is calculated by dividing the present value of all cash inflows by the initial investment. Projects with higher profitability index are better.