In capital budgeting, the profitability index is generally calculated as:
Correct answer: C. Present value of inflows divided by initial investment
- A. Initial investment divided by present value of inflows
- B. Accounting profit divided by total assets
- C. Present value of inflows divided by initial investment
- D. Cash inflows divided by project life
Explanation
The profitability index compares the present value of future cash inflows with the initial investment. A value above 1 generally indicates that the project creates value at the selected discount rate.
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Business finance explains how organisations plan, obtain and use money while balancing risk, return and liquidity. Topics include financial statements, time value of money, budgeting, working capital, capital structure, sources of finance, investment appraisal and cost of capital. Capital budgeting evaluates long-term projects, whereas working capital manages day-to-day operations.
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