Profitability Index Formula & Example. The profitability index (PI) is a measure of a project's or investment's attractiveness. Profitability Index (PI) is a capital budgeting technique to evaluate the investment projects for their viability or profitability. Application The profitability index is often used to rank a firm's investments and/or projects alongside others. Profitability index (PI) is the ratio of investment to pay off a suggested project. a project with a large total net present value might be rejected if its profitability index were lower than that of a competing, but much smaller project. the only difference is that it results in a ratio, rather than a … In itself it is a modification of the net present value (NPV) method. Calculation of profitability index is possible with a simple formula with inputs as – discount rate, cash inflows, and outflows. OR. ABC is considering investing in a high class production plant which will smooth out its production process and will increase production up to 40 %. It is a useful capital budgeting technique for grading projects because it measures the value created per unit of investment made by the investor. . the solution provided by the profitability index thus the relative importance. A profitability index is usually calculated by people or teams that are close to the projects or companies being examined. Profitability index (PI), also known as profit investment ratio (PIR) and value investment ratio (VIR), is the ratio of payoff to investment of a proposed project.It is a useful tool for ranking projects because it allows you to quantify the amount of value created per unit of investment. This results in a strong profitability index of 1.4, which would normally be accepted. + CF n × (1 + r)-n] / CF 0. Where, PI is the profitability index… Pages 9 This preview shows page 6 - 8 out of 9 pages. This calculator uses the following formula to calculate the profitability index: Profitability Index (PI) = Present Value of Future Cash Flows / Initial Investment. Example of the Profitability Index. We calculated that the net present value of all of the lemonade stand's cash flows was $34.20. But, this production plant needs an initial investment of $ 20 million. This technique is also known as Profit Investment Ratio (PIR), Benefit-Cost Ratio and Value Investment Ratio (VIR). Step 4: Calculate profitability Index as follows: Profitability Index = 9677.87/10,000 = 0.97. . The cash flows and calculations are shown below: Download Profitability Index Excel Spreadsheet. Discounted cash flow technique is used in arriving at the profitability index. PI = [ CF 1 × (1 + r)-1 + CF 2 × (1 + r)-2 + . The solution provided by the profitability index thus. School Ashford University; Course Title HCA 312; Uploaded By LadyIsabella1. In our example, the total is 9677.87. Since the profitability index is less than one, this project should not be accepted. How is the p.i a variation on the net present value concept? At the company's standard discount rate, the present value of the cash flows expected from the project is $140,000. It is also known as a benefit-cost ratio. The difference between them is that the NPV is an absolute measure, and the PI is a relative measure of a project. Investors often look at equity opportunities that they feel close to at first, for example, or an executive team may calculate the profitability index with optimistic figures because they have high hopes for a specific project. Profitability Index = Present value of future cash flows / Initial investment. Example. The profitability index (PI) is one of the methods used in capital budgeting for project valuation. Profitability index = present value of future cash flows / initial investment. 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