Enter the initial investment, cash flows, and discount rate into the profitability index calculator. The calculator will display the PI ratio.

Profitability Index Formula

The following formula is used to calculate the profitability index of an investment.

PI = NPV / I
  • Where PI is the profitability index
  • NPV is the present value of future cash flows
  • I is the initial investment

Further, the npv of future cash flows can be calculated using the following formula.

CF1 Ã— (1 + r) -1 + CF2 Ã— (1 + r) -2 + . . . 

  • Where CF is the cash flows of each corresponding year
  • r is the discount rate

What is a Profitability Index?

The Profitability Index, also known as the Profit Investment Ratio (PIR) or Benefit-Cost Ratio (BCR), is a financial metric used to evaluate the potential profitability of an investment or project.

The Profitability Index serves as an indicator of the value created by an investment relative to its cost.

When the index is greater than 1, it signifies that the project is expected to generate more value than the initial investment, making it potentially profitable.

If the index is less than 1, the investment is projected to generate less value than the amount invested, indicating a potential loss.

This metric is crucial in decision-making processes for businesses and investors as it helps prioritize and compare different investment opportunities. By comparing the profitability indices of various projects, decision-makers can identify the most financially viable option. The higher the index, the more attractive the investment becomes.

The Profitability Index considers the time value of money, as it discounts future cash flows to their present value. This enables a more accurate assessment of the project’s profitability, considering the potential impacts of inflation and the opportunity cost of investing those funds elsewhere.

How to calculate a profitability index?

How to calculate a profitability index

  1. First determine the initial investment and discount rate

    This will be CF0 and r, respectively in the formula above.

  2. Next, estimate the cash flows derived from the investment

    Estimate the cash flows for each year following the investment.

  3. Finally, calculate the PI

    Calculate the profitability index using the NPV of the cash flows and the initial investment.

FAQ

What is the profitability index?

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. The higher the index ratio the more profitable an investment is. The PI depends on cash flows, investment amounts, and discount rates.

How do you increase the profitability index?

The three ways to increase the PI are to decrease the discount rate, increase the cash flows, or decrease the initial investment amount.

profitability index calculator
profitability index formula