What Are the Different Uses of the Profitability Index?
The profitability index is also known as the "benefit / cost ratio". After the initial investment, the ratio of the present value of all expected future cash flows to the initial investment. The calculation method is: present value of future cash flow / initial investment amount. It is used to measure the value created by each unit of currency invested. If the index is greater than 1, the net present value of the investment is positive; if it is less than 1, the net present value of the investment is negative. The index does not consider the impact of project size on profitability, but when there are many optional projects but limited funds, the index can be used to initially sort the projects. Usually resources should be allocated to the project with the highest index. [1]
Profitability index
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- Chinese name
- Profitability index
- Foreign name
- PI
- Solid
- Present value and initial investment of future cash flows
- Express
- Relative profitability of investment projects
- Meaning
- Has a special role in evaluating project benefits
- The profitability index is also known as the "benefit / cost ratio". After the initial investment, the ratio of the present value of all expected future cash flows to the initial investment. The calculation method is: present value of future cash flow / initial investment amount. It is used to measure the value created by each unit of currency invested. If the index is greater than 1, the net present value of the investment is positive; if it is less than 1, the net present value of the investment is negative. The index does not consider the impact of project size on profitability, but when there are many optional projects but limited funds, the index can be used to initially sort the projects. Usually resources should be allocated to the project with the highest index. [1]
- formula
- Formulated as follows:
- Profitability Index (PI) = Present value of subsequent cash flows from initial investment / Initial investment
- Generally speaking, if the profitability index of an investment project is greater than 1.0, the investment project is acceptable. The higher the profitability index of an investment project, the greater the profitability of the investment project and the greater the investment feasibility.
- The profitability index method not only notices the cash inflow of the project, but also the cash outflow of the project, which has a special role in evaluating the project's income. Moreover, it takes into account the time value of money and all cash inflows and outflows throughout the project period.