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

Related Articles
  1. Investing

    Understanding the Profitability Index

    The profitability index (PI) is a modification of the net present value method of assessing an investment’s attractiveness.
  2. Financial Advisor

    Happy Pi Day: How to Save Money Using Pi

    Happy 3/14, or "Pi Day." As Pizza Hut pointed out on its blog, "Pi is everyone's favorite irrational number."
  3. Investing

    An Introduction To Capital Budgeting

    We look at three widely used valuation methods and figure out how companies justify spending.
  4. Small Business

    Calculating Net Present Value at Different Points Using Excel

    Calculating the net present value (NPV) of your investment projects using Excel.
  5. Financial Advisor

    A Guide on the Risk-Adjusted Discount Rate

    When a project or investment faces higher amounts of risk or uncertainty, it may be appropriate to utilize the risk-adjusted discount rate.
  6. 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.
  7. Investing

    What is an Index?

    An index is a statistical means of calculating a change in an economy or market.
  8. 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.
Frequently Asked Questions
  1. How do you calculate r-squared in Excel?

    Calculate R-squared in Microsoft Excel by creating two data ranges to correlate. Use the Correlation formula to correlate ...
  2. What is the Difference Between International Monetary Fund and the World Bank?

    Learn about the International Monetary Fund and the World Bank and how they are differentiated by their respective functions ...
  3. Where Did the Bull and Bear Market Get Their Names?

    The terms bull and bear are used to describe general actions and attitudes, or sentiment, either of an individual (bear and ...
  4. What's the difference between Google's GOOG and GOOGL stock tickers?

    Learn the difference between Google's GOOG and GOOGL ticker symbols. Splitting shares into classes prevents management from ...
Trading Center