Profitability Index Formula with Calculator

Using a required rate of return of 10%, we should opt for project B because it has a profitability index of 1.53, compared to only 1.09 in the case of project A. This means that if we have the NPV of a project, we can easily calculate the profitability index. Simple mortgage calculator which is used to calculate Profitability Index (PI) based on present value and initial investment. The following formula is used to calculate the profitability index of an investment. This is the opportunity cost, or alternative, you have in addition to this investment.

This profitability index calculator can be used to figure out the benefit to cost ratio of an investment. Profitability index is the present value of future cash flows divided by the initial investment. When the profitability index is greater than 1.0, the present value of cash flows must be greater than the initial investment. Ideally the PI ratio of more than 1 is expected from the project, which means the value of future cash flows will be greater than the initial investments and it reflects the profitability of a proposed project. The profitability index instead calculates the ratio between the initial investment and the present value of future cashflow. If the initial investment and the present value of future cash flow are exactly equal, the index is 1.0.

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The profitability index is a measure of how much of a return on investment is offered by each project. This is the final value returned to you at the end of the last investment period. For example, if you invested $1,000 in a bond and that $1,000 was returned at the bond’s expiration, then enter that amount here.

Profitability index, or PI for short, is a term used in business to describe the ratio of an asset or investment’s profitability in the future. This is the net present value of money, which takes into consideration the time value of money. This value simply discounts the cash flows and final value of the investment by the opportunity cost. It is considered that when NPV is $0+ and the profitability index is 1+, the project is a healthy venture.

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In corporate finance, the primary use case for the PI ratio is for ranking projects and capital investments. Running a profitable business demands a lot of investments and assessing them for profitability is essential. The profitability index (PI), also known as profit investment ratio (PIR) is a method to describe the relationship between cost and benefits of a project.

• Firms use the profitability index to determine the relationship between costs and benefits for a proposed project.
• From a glance, it is easy to think that the profitability index is the same as NPV as it also uses present value of future cashflows and the purchase price.
• The Profitability Index is a measure firms use to determine the relationship between the costs and benefits of doing a proposed project.
• This decision rule is equivalent to using the NPV to choose among projects.

One could annualize these net returns using the equivalent annual annuity formula, for the sake of like comparison. Zilculator helps real estate professionals calculate profitability index easily. For each of the following projects compute Post pay back profitability and Post Pay back profitability Index. However, since both PIs are less than 1.0, the company may end up forgoing either project in favor of a better opportunity elsewhere.

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This is the total number of time periods that you receive the cash flow entered earlier. Please note that the definition (year, quarter, month, week, or day) must be consistent throughout this example. The higher the PI ratio, the https://turbo-tax.org/are-subject-to/ more attractive the proposed project is and the more likely it will be pursued. Another variation of the PI formula adds the initial investment to the net present value (NPV), which is then divided by the initial investment.

In other words, there may be a positive IRR and a payback period, while still having a PI less than 1, and a NPV less than $0. The discount rate is an important part of the profitability index calculation. With that said, for purposes of presenting a project or capital investment’s benefits on a per-dollar basis of the initial investment, the profitability index is more practical since it is standardized. From a glance, it is easy to think that the profitability index is the same as NPV as it also uses present value of future cashflows and the purchase price. However the profitability index makes it easier to compare properties that have a different purchase price.

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The profitability index is used for comparison and contrast when a company has several investments and projects it is considering undertaking. The PI is especially useful when a company has limited resources and can’t pursue all potential projects, as it can be used to prioritize which projects to pursue first. The index can be used alongside other metrics to determine which is the best investment. The Profitability Index is a measure firms use to determine the relationship between the costs and benefits of doing a proposed project.

The only thing we ask in return is for you to like our facebook page or follow us on twitter. This decision rule is equivalent to using the NPV to choose among projects. In particular, a negative (positive) NPV corresponds with a PI index below (above) 1. The profitability index is also called the profit investment ratio (PIR), cost-benefit ratio, or the value investment ratio (VIR). The purpose of this measure of PI is to help investors and managers determine whether or not a given project has the potential to be profitable. Free online Profitability Index Calculator – this helps you determine the profitability index of your investment projects.