Profitability Index (PI) or Benefit-Cost Ratio measures the ratio of the present value of expected cash flows of a project to its initial investment:
$$PI = \frac{\sum_{i=1}^{t}\frac {C_{i}}{(1+r)^{i}}}{C_{0}}$$
C0— initial investment;
r— discount rate (e.g., weighted average cost of capital);
t— number of periods.
Essentially, the profitability index is a percentage or ratio form of NPV.
General decision rules for using the Profitability Index method:
- Accept a project if PI > 1;
- Reject a project if PI < 1.
See also:
- Net Present Value (NPV)
- Internal Rate of Return (IRR)
- Modified Internal Rate of Return (MIRR)
- Future Value
- Present Value
- Present Value of Annuity
Profitability Index FAQ
What is the profitability index?
The profitability index measures the value created per unit of invested capital using discounted cash flows.
How do you interpret PI?
A PI above 1 usually means the project is expected to create value, while a PI below 1 suggests rejection.
