Profitability Index Rule

AAA

DEFINITION of 'Profitability Index Rule'

A regulation for evaluating whether to proceed with a project or investment. The profitability index rule states: If the profitability index or ratio is greater than 1, the project is profitable and may receive the green signal to proceed. Conversely, if the profitability ratio or index is below, the optimum course of action may be to reject or abandon the project.







INVESTOPEDIA EXPLAINS 'Profitability Index Rule'

The profitability index rule is a variation of the net present value (NPV) rule. In general, if NPV is positive, the profitability index would be greater than 1; if NPV is negative, the profitability index would be below 1. The profitability index differs from NPV in one important respect; Being a ratio, it ignores the scale of investment and provides no indication of the size of the actual cash flows.


For example, a project with an initial investment of $1 million, and present value of future cash flows of $1.2 million, would have a profitability index of 1.2. Based on the profitability index rule, the project would proceed.

RELATED TERMS
  1. Net Present Value - NPV

    The difference between the present value of cash inflows and ...
  2. Capital Budgeting

    The process in which a business determines whether projects such ...
  3. Cash Flow

    1. A revenue or expense stream that changes a cash account over ...
  4. Benefit Cost Ratio - BCR

    A ratio attempting to identify the relationship between the cost ...
  5. Profitability Index

    An index that attempts to identify the relationship between the ...
  6. Investment Income Ratio

    The ratio of an insurance company’s net investment income to ...
Related Articles
  1. Investing

    Using DCF In Biotech Valuation

    Valuing firms in this sector can seem like a black art, but there is a systematic way to pin a price on potential.
  2. Forex Education

    Time Value Of Money: Determining Your Future Worth

    Determining monthly contributions to college funds, retirement plans or savings is easy with this calculation.
  3. Fundamental Analysis

    Internal Rate Of Return: An Inside Look

    Use this method to choose which project or investment is right for you.
  4. Budgeting

    Which is a better measure for capital budgeting, IRR or NPV?

    In capital budgeting, there are a number of different approaches that can be used to evaluate any given project, and each approach has its own distinct advantages and disadvantages.All other ...
  5. Options & Futures

    What are the disadvantages of using net present value as an investment criterion?

    While net present value (NPV) calculations are useful when you are valuing investment opportunities, the process is by no means perfect.The biggest disadvantage to the calculation of NPV is its ...
  6. Investing Basics

    What is the difference between a P&L statement and a balance sheet?

    Take a deeper look at the differences between the profit and loss statement and the balance sheet, two of the most important financial accounting documents.
  7. Personal Finance

    What is a P&L statement used for?

    Discover how the profit and loss statement is used by investors, accountants and business managers to assess the health and business practices of a company.
  8. Investing

    How does Facebook (FB) make money?

    Examine third quarter 2014 revenue data for Facebook and increases in advertising, mobile advertising, daily active users and mobile daily active users.
  9. Investing Basics

    How does Twitter (TWTR) make money?

    Learn how Twitter earns revenue, including the company's use of three targeted advertising streams and data farming and licensing.
  10. Investing Basics

    Why is it important to understand the Circular Flow Of Income when making investment decisions?

    Find out why investors should pay attention to a firm's circular flow of income model to measure its efficiency and evaluate its use of profits.

You May Also Like

Hot Definitions
  1. Commodity

    1. A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often ...
  2. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's balance sheet as a liability, until the services have been ...
  3. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  4. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  5. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  6. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
Trading Center