
A profitability index attempts to identify the relationship between the costs and benefits of a proposed project. The profitability index is calculated by dividing the present value of the project's future cash flows by the initial investment. A PI greater than 1.0 indicates that profitability is positive, while a PI of less than 1.0 indicates that the project will lose money. As values on the profitability index increase, so does the financial attractiveness of the proposed project.
The PI ratio is calculated as follows:
PV of Future Cash Flows
Initial Investment
A ratio of 1.0 is logically the lowest acceptable measure for the index. Any value lower than 1.0 would indicate that the project's PV is less than the initial investment, and the project should be rejected or abandoned. The profitability index rule states that the ratio must be greater than 1.0 for the project to proceed.
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. Essentially, the PI tells us how much value we receive per dollar invested. In this example, each dollar invested yields $1.20.
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. Thus, calculations of PI and NPV would both lead to the same decision regarding whether to proceed with or abandon a project.
However, 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.
The PI can also be thought of as turning a project's NPV into a percentage rate.
(Find some profitable ideas in 8 Ways To Make Money With Real Estate and Outside The Box Ways To Get Money.)
Capital Budgeting

Investing
Understanding the Profitability Index
The profitability index (PI) is a modification of the net present value method of assessing an investmentâ€™s attractiveness. 
Financial Advisor
Happy Pi Day: How to Save Money Using Pi (DPZ, YUM)
Happy 3/14, or "Pi Day." As Pizza Hut pointed out on its blog, "Pi is everyone's favorite irrational number." 
Investing
An Introduction To Capital Budgeting
We look at three widely used valuation methods and figure out how companies justify spending. 
Managing Wealth
What's a Hurdle Rate?
Hurdle rate has two meanings. In the business world, a business typically makes a decision on a capital project based on the net present value approach. To determine the net present value, the ... 
Small Business
Calculating Net Present Value at Different Points Using Excel
Calculating the net present value (NPV) of your investment projects using Excel. 
Trading
Using Index Futures To Predict The Future
Want to know whether the stock market will open up or down? Check out the index futures. 
Personal Finance
Project Manager: Job Description & Average Salary
Discover more about the specific tasks that project managers are responsible for and the average salary that can be expected in such a position. 
Small Business
What Exactly Do Project Managers Do?
While supervision is one important part of the job, a lot more goes into project management than just watching everyone work. 
Investing
What is an Index?
An index is a statistical means of calculating a change in an economy or market. 
Financial Advisor
Understanding Net Present Value
Learn how this value is used to determine the worth of a project.