Lecture 28 - Business Finance (ACC501) Lesson 28 Review of...

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148 Business Finance (ACC501) Lesson 28 Review of the Previous Lecture Net Present Value Average Accounting Return The Payback Rule Internal Rate of Return Topics under Discussion Profitability Index Capital Budgeting Practice Making Capital Investment Decisions Project Cash Flows Profitability Index Also defined as benefit cost ratio, this index is defined as the present value of the future cash flows divided by the initial investment. So if a project cost $200 and the present value of its future cash flows is $220, then the profitability index would be PI = $220 /200 = 1.10 Also, the NPV for this investment is $20, so this a desirable investment. The profitability index for a positive NPV investment would be bigger than 1.00 and less than 1.00 for a negative NPV investment The PI of 1.10 tells us that per dollar invested, $1.10 in value or $0.10 in NPV results. So it measures value created per dollar invested. It is often proposed as a measure of performance of government or other non-profit investments. When capital is scarce, it is sensible approach to allocate it to those projects with highest PI Consider an investment which costs $5 and has a $10 present value and an investment costing $100 with a $150 present value.
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Lecture 28 - Business Finance (ACC501) Lesson 28 Review of...

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