The profitability index or relationship benefit -cost of a project is the present value of future net cash flows over the initial cash outlay. The index can be expressed as. As long as the profitability index is 1.00 or higher, the investment proposal will be acceptable. Below this post is all about BusinessStudyNotes. Business Study Notes is all about BBA, Mba, and B.com & M.com related studies and notes online. We may also say that the students of MBA, BBA, and B.com & M.com may easily get ready for their exams through business study notes.
For any given project, the net present value method and the profitability index give the same signs of acceptance or rejection. If we have to choose between mutually exclusive projects, the measure of net present value is preferred because it expresses in absolute terms the expected economic contribution of the project. In contrast, the performance index expresses only relative profitability.
Mutual exclusion and dependence
When evaluating a group of investment proposals, we must determine if the proposals are independent of each other. A proposal is mutually exclusive if its acceptance prevents the acceptance of one or more different proposals. For example, if the organization is considering investing in one of two temperatures control systems, acceptance of one system will prevent acceptance of the other. Two mutually exclusive proposals can not be accepted.
A contingent or dependent proposal depends on the acceptance of one or more diverse proposals. The addition of a large machine may need construction of a new wing to house it. Contingent proposals should be part of our thinking when we consider the original dependent proposal. By recognizing dependency, we can make investment decisions that include them.