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,Â 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 Rule
The net present value rule (NPV) states an investment should ... 
The Net Internal Rate of Return ...
Net internal rate of return (net IRR) is a performance measure ... 
Conventional Cash Flow
Conventional cash flow is a series of inward and outward cash ... 
Initial Cash Flow
Initial cash flow is the amount of money paid out or received ... 
Adjusted Present Value  APV
The Net Present Value (NPV) of a project if financed solely by ... 
Rate of Return
A rate of return is the gain or loss on an investment over a ...

Investing
Internal Rate of Return: An Inside Look
The internal rate of return can be used to measure an compare capital projects, stock buyback programs, and investments to determine which will yield the most favorable return. 
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. 
Financial Advisor
A Guide on the RiskAdjusted Discount Rate
When a project or investment faces higher amounts of risk or uncertainty, it may be appropriate to utilize the riskadjusted discount rate. 
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 
Financial Advisor
How to Compare Permanent Life Insurance Policies
How you can use the internal rate of return to compare and purchase a permanent life insurance policy. 
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. 
Investing
Understanding profit metrics: Gross, operating and net profits
Rather than relying solely on a company's net profit figures, seasoned investors will often look at gross profit and operating profit as well.

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 >> 
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 use internal rate of return to calculate a capital budget?
Learn about how the internal rate of return is used in the creation of a capital budget along with net present value and ... 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 >> 
Why is the Modified Internal Rate Of Return (MIRR) preferable to the regular internal ...
See why the modified internal rate of return is often a superior metric to the classic internal rate of return for assessing ... Read Answer >>