The profitability index of 0.40 for project A means that the project earns a net present value of 40 cents for every dollar of initial investment. Based on the profitability index, we should accept projects B, C and G. This combination of projects would exhaust the capital budget of $100,000 while maximizing the net present value of the projects accepted.

Note that this analysis is based on the assumption that the capital constraint is for the current period only and that the initial investments on all these projects will occur in the current period4. It also highlights the cost of the capital rationing constraint for this firm; the net present value of the projects rejected as a consequence of the constraint is $70 million.

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