Which statement is true regarding the Profitability Index (PI)?

The Profitability Index (PI) is indeed a valuable tool in capital budgeting that helps assess the profitability of an investment relative to its cost. One important characteristic of PI is that it can lead to misleading conclusions when evaluating mutually exclusive projects. This is because PI is a ratio of the present value of future cash flows to the initial investment, and it encourages selection based on the highest ratio. While this can make a project appear attractive, it does not consider the scale of the investments. Therefore, it is possible to favor a project with a higher PI that has a lower total return when compared to another project with a lower PI that delivers a higher overall profit.

This nuance is vital for decision-making, particularly when the projects under consideration cannot all be pursued simultaneously due to resource constraints. In this scenario, relying solely on PI could result in choosing a project that seems better on a percentage basis but is not the most beneficial choice when considering total returns or cash flow.

Other statements miss the specific context of PI's application and limitations. For instance, while PI is often applied in evaluating long-term investments, it is not exclusively limited to them. It is certainly useful in various investment horizons. The assertion that it is unnecessary for limited resource investments overlooks the times when PI