Question

If a project has a positive net present value, which of the following must be true?

a) the internal rate of return is less than the cost of capital

b) the profitability index is less than one

c) the profitability index is greater than one

d) the internal rate of return equals the cost of capital

Answer 1

Profitability index s the ratio between present value of all future cash inflows and initial investment. It indicates how much dollar a project creating for every $1 invested.

Profitability index is less than 1, the project producing less amount than the investment and undergoing a loss. NPV of project in this case is negative and internal rate of return is less than company’s cost of capital.

Profitability index equals to 1, the project producing same amount as the investment and in a state of break-even i.e. no profit no loss. NPV of project in this case is zero. Internal rate of return is same as firm’s required rate of return.

Profitability index greater than 1, every dollar invested is producing more than $1. The project is profitable. NPV of project is positive and IRR is higher than company’s required rate of return.

Hence option “c) The profitability index is greater than one” is correct answer.