Indicate the correct code from the following that does not represent the Profitability Index for an investment proposal of a firm:

(a) Average annual net income earned divided by the investment

(b) Equating annual net cash inflows to investment

(c) Ratio of present value of future cash inflows to investment making it equal to zero

(d) Ratio of present value of future cash inflows to present cash outflows

The correct answer is (a), (b), and (c) only. 

Key Points

•  A profitability index is a financial tool that tells us whether an investment should be accepted or rejected.
• It uses the time value concept of money. 

• The profitability index helps in ranking investments and deciding the best investment that should be made.

• PI greater than one indicates that the present value of future cash inflows from the investment is more than the initial investment, thereby indicating that it will earn profits.

• PI of less than one indicates a loss from the investment. PI equal to one means that there are no profits.

• The formula for the profitability index is as follows:

Profitability Index= Present value of future cash inflows ÷ Present value of cash outflows

Decision criteria under Profitability Index:

• If PI is greater than 1, accept the investment. 
• If PI is less than 1, reject the investment.
• If PI = 1, then indifferent (may accept or reject the decision)

In the above statements only statement d ie. The ratio of the present value of future cash inflows to present cash outflows is related to Profitability Index and all other statements are irrelevant to the profitability index. 

Hence, the correct answer is (a), (b), and (c) only.