What is the 'Profitability Index Rule'
The profitability index rule is 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 can proceed. Conversely, if the profitability ratio or index is below 1, the optimum course of action may be to reject or abandon the project.
BREAKING DOWN '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: since it is a ratio, it 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, yet stakeholders would not know the initial capital expenditure required.
Profitability Index Rule, Net Present Value, and Internal Rate of Return (IRR)
Like the profitability index rule, both net present value (NPV) and internal rate of return (IRR) also measure if a company should invest in a particular new project or initiative. Broken down further, the net present value discounts aftertax cash flows of a potential project by the weighted average cost of capital (WACC).
To calculate NPV:
1. First identify all cash inflows and cash outflows.
2. Next, determine an appropriate discount rate (r).
3. Use the discount rate to find the present value of all cash inflows and outflows.
4. Take the sum of all present values.
The NPV method reveals exactly how profitable a project will be in comparison to alternatives. When a project has a positive net present value, it should be accepted; if negative, it should be rejected. When weighing several positive NPV options, the ones with the higher discounted values should be accepted.
In contrast the IRR rule states that if the internal rate of return (IRR) on a project is greater than the minimum required rate of return, or the cost of capital, then the project or investment should proceed. Conversely, if the IRR is lower than the cost of capital, then the best course of action may be to reject it.

Net Present Value  NPV
Net Present Value (NPV) is the difference between the present ... 
Internal Rate of Return  IRR
Internal Rate of Return (IRR) is a metric used in capital budgeting ... 
Net Present Value Rule
The net present value rule (NPV) states that an investment should ... 
IRR
The currency abbreviation or currency symbol for the Iranian ... 
The Net Internal Rate of Return ...
Net internal rate of return (net IRR) is a performance measure ... 
Unconventional Cash Flow
An unconventional cash flow is a series of inward and outward ...

Investing
An Introduction To Capital Budgeting
We look at three widely used valuation methods and figure out how companies justify spending. 
Small Business
Calculating IRR with Excel
Find out how to calculate the internal rate of return on investments using Microsoft Excel, as illustrated in different investment scenarios. 
Investing
Return on investment versus internal rate of return
Read about the similarities and differences between an investment's internal rate of return (IRR) and its return on investment (ROI). 
Financial Advisor
Understanding Internal Rate Of Return
Internal rate of return, or IRR, is one of the most popular methods of evaluating potential projects. Learn more about this important metric. 
Small Business
How to Calculate NPV Using XNPV Function in Excel
Learn how to calculate the net present value (NPV) of your investment projects using builtin functions from Excel using the XNPV function. 
Investing
Private Equity on Steroids: How Debt Fuels Outsized Returns
Hot Air: Many private equity firms use a legal technique that can boost returns by 25% or more, Bloomberg says 
Trading
Using index futures to predict the future
Want to know whether the stock market will open up or down? Learn about index futures and how they can help predict how the market will trade. 
Trading
Index Options: A HowTo Guide
Index options, financial derivatives that derive their value from a stock index, can provide stability and peace of mind for less risky investors. 
Investing
Is Net Income The Same As Profit?
Net income and profit both deal with positive cash flow, but there are important differences between the two concepts.

Which is better for capital budgeting – IRR or NPV?
All other things being equal, using IRR and NPV measurements to evaluate projects often results in the same findings. However, ... Read Answer >> 
How do you calculate IRR in Excel?
Understand how to calculate the internal rate of return (IRR) in Excel and how it's used to determine anticipated yield per ... Read Answer >> 
How do you use discounted cash flow to calculate a capital budget?
Learn how discounted cash flows are used in creating capital budgets as a part of the net present value and internal rate ... Read Answer >> 
What's the difference between weighted average cost of capital (WACC) and internal ...
Both weighted average cost of capital (WACC) and internal rate of return (IRR) are great measures for assessing value, but ... Read Answer >> 
How do I use Excel to get discount rate over time?
Learn how to calculate discount rate in Microsoft Excel and how to find the discount factor over a specified number of years. Read Answer >> 
What is the formula for calculating the internal rate of return (IRR)?
Learn about the internal rate of return, an important concept in determining the relative attractiveness of different investments. Read Answer >>