COST ACCOUNTING
CAPITAL BUDGETING
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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Requires estimate of cost of capital
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May not give value-maximizing decisions for mutually exclusive projects
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Provides only relative profitability
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Tells whether firm value is increased
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Detailed explanation-1: -One disadvantage of using a profitability index is that it does not necessarily measure the value of a business. It only shows the company’s ability to generate profits from investments. It can sometimes indicate bad management techniques. One example of this is continually investing in unprofitable ventures.
Detailed explanation-2: -Disadvantages of the Profitability Index The profitability index requires an estimate of the cost of capital to calculate. In mutually exclusive projects where the initial investments are different, it may not indicate the correct decision.
Detailed explanation-3: -The main disadvantage with the profitability index is the you may incorrectly choose projects when considering mutually exclusive investments.
Detailed explanation-4: -The answer is c. Profitability, by definition, is calculated as the ratio of present value of inflow to the present value of the outflows.