## Profitability Index

Profitability Index Calculator is developed for efficient calculation of profitability index in order to analyze different capital investments opportunities. PI is a capital budgeting technique useful in evaluating various investment proposals available with the investors. Project having PI greater than or equal to 1 falls in the category of investments that will pay off the costs. This technique of investment appraisal takes into account the concept of time value of money which makes decision making more simplified for the management. Also profitability index plays a great role in capital rationing decisions.

## Formula for Calculating Profitability Index

In order to calculate the profitability index one has to calculate the PV of expected cash inflows and the total initial investment of the project. The formula for calculating the profitability index is as follows:

Profitability Index (PI) = PV of Expected Cash Inflows / Initial Investment

## About the Calculator

The PI Calculator provides a quick result of the calculation. The users just have to provide following data to the calculator.

- Present value of future / expected cash inflows.
- Initial investment.

## Calculator

## How to Calculate using Calculator

The user simply have to insert the following figure in the calculator to obtain the result of profitability index.

### Present Value of Future / Expected Cash Inflows

The expected returns or future cash inflows are discounted at a rate to find out the PV of cash flows. The time value of money plays a major role in calculating present value.

### Initial Investments

The costs incurred initially plus the PV of cost, if any, expected to be incurred in the future, are taken into account.

## Example of Profitability Index

Let us try to understand this concept with the help of an example. A company has invested $50,000 in a project for a period of 5 years. Expected cash flow at the end of 1st, 2nd, 3rd, 4th and 5th year is $20,000, $24,000, $27,000, $15,000 and $10,000 respectively. Expected rate of return is 10%. Calculate Profitability Index.

Year | Expected Cash Flows ($) | PV @ 10% ($) |

1 | 20,000 | 18,182 |

2 | 24,000 | 19,835 |

3 | 22,000 | 16,529 |

4 | 15,000 | 10,245 |

5 | 10,000 | 6,209 |

Total | 91,000 | 71,000 |

Therefore, initial investment = $50,000

Present value of expected cash flows = 71,000

Profitability Index = 71,000/50,000 = 1.42

## Interpretation of Profitability Index

If the PI of the project is greater than or equal to 1, it is treated to be a good project and can be accepted for execution. In the example above, the profitability index is 1.42 which is greater than 1. This means that the project is worth accepting.

## Cautions

Profitability Index is a relative indicator and hence, it does not provide proper basis for making a comparison between two different projects having vast difference in terms of values. Therefore, net present value is a better investment appraisal technique as compared to profitability index. Also profitability index method does not consider opportunity costs which may lead to great difference while evaluating projects.

To know more about NPV – *Net Present Value*