Final answer:
A firm should consider the Profitability Index (PI) and Internal Rate of Return (IRR) of a project with NPV of $0 before deciding to invest, as these indicators reveal more about the project's financial desirability and potential profitability compared to the firm's cost of capital and alternative investments.
Step-by-step explanation:
When determining whether a firm should invest in projects with a Net Present Value (NPV) of $0, it is essential to consider additional financial metrics such as the Profitability Index (PI) and the Internal Rate of Return (IRR). A project with an NPV of $0 implies that it is expected to break even from a financial perspective, considering the time value of money and the firm's capital costs. However, the PI and IRR can offer deeper insights into the project's potential performance relative to alternative investments or the cost of capital.
If the project's IRR is greater than the firm's cost of capital, it means the project is expected to generate a return higher than what could be earned from a different investment with similar risk, suggesting that the investment is financially viable. Similarly, a PI greater than 1 indicates that the project's present value of cash flows exceeds the initial investment, showing potential profitability.
It is also crucial for the firm to consider other factors such as strategic alignment, risk, potential for future growth, and project timelines before making a final investment decision.