Enter the initial investment, cash flows, and discount rate into the profitability index calculator. The calculator will display the PI ratio.
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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 × (1 + r) -1 + CF2 × (1 + r) -2 + . . .
- Where CF is the cash flows of each corresponding year
- r is the discount rate
Profitability Index Definition
A profitability index is a measure of the profitability of an investment and is defined as the ratio of the net present value of cash flows to the price of the initial investment.
How to calculate a profitability index?
How to calculate a profitability index
- First determine the initial investment and discount rate
This will be CF0 and r respectively in the formula above.
- Next, estimate the cash flows derived from the investment
Estimate the cash flows for each year following the investment.
- Finally, calculate the PI
Calculate the profitability index using the NPV of the cash flows and the initial investment.
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.
The 3 ways to increase the PI are to decrease the discount rate, increase the cash flows, or decrease the initial investment amount.