Profitability index (PI) / Benefit-cost ratio

Last updated: 17.03.2016

Profitability index is a method used for investment appraisal that is based on discounted cash-flow methodology. It calculates the present value of cash flows generated by the project per a unit of capital outlay. As such it is helpful in decision-making in situations when the company cannot undertake all acceptable projects due to the limited budget.

 

Formula

NPV / present value of investment

 

PI = 1 → NPV = 0 → IRR = discount rate

 

  • if PI > 1 → the investment adds value to the company → can be accepted (not necessarily must be, because there can be alternative projects having higher PI or budget can be insufficient)
  • if PI < 1 → the investment does not add value to the company → shall be refused


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