Here we will have an in depth view of the way Profitability Index or PI is used to decide financial viability of an investment. You will find a definition, formula, example, calculation with Profitability Index along with a handy calculator.
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Profitability Index Calculator
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| WallStreet PI v1.0 Calculator |
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Profitability Index using TI BA II Plus
If you own a TI BA II Plus Financial calculator, you will find this tutorial on how to find profitability index with TI BA II Plus handy. It shows you steps you need to know that will help you find profitability index with TI BA II Plus.
How do you define Profitability Index?
Profitability Index is defined as the present value of expected cash inflows over the Initial Cash Outlay. It is a ratio of the present value or cash inflows and ICO. A Profitability Index of one yields the internal rate of return. A Profitability Index of less than one suggests that we should reject the proposal and value of one or greater suggests that investment proposal should be accepted.
What is the formula for Profitability Index ?
Profitability Index Example
Let us examine finding Profitability Index or PI with an example investment proposal. Let us say we were offered a series of cash inflows at the end of each of the next four years as $500, $400, $300, and $100. And the Initial Cost Outlay for this proposal is $1,000 and the discount rate or return is 12%.
Profitability Index at 12%
| Year | Net Cash Flows | PVIF @ 12% | Present Value |
| 1 | 500 | 0.893 | $446.50 |
| 2 | 400 | 0.797 | $318.80 |
| 3 | 300 | 0.712 | $213.60 |
| 4 | 1000 | 0.636 | $63.60 |
| Profitability Index = 1.0425 | $1,042.50/1,000 | ||
Profitability Index at at 15%
| Year | Net Cash Flows | PVIF @ 15% | Present Value |
| 1 | 500 | 0.870 | $435 |
| 2 | 400 | 0.756 | $302.40 |
| 3 | 300 | 0.658 | $197.40 |
| 4 | 100 | 0.572 | $57.20 |
| NPV =0.992 | $992/$1,000 | ||
Acceptance Criteria
At 12% the Profitability Index is 1.0425 which is greater than one thus the proposal worth the money yet at 15% discount rate the Profitability Index is 0.992 which is less than 1 thus the proposal should be rejected at this discount rate.
User submitted Profitability Index Questions/Problems
Asked:
you are provided with information on a certain firm, from wich a capital budgeting decision must be made.the firm estimates that the initial investment will amount to R1 800 06 and that the nrt cash inflows during the 5 year lifespan of the project will be as follows year 1-r500 000 year 2-r650 000;year 3-r480 000;year4 R 400 000;year 5:r200 000...required: cost of capital of 12% evaluate the following : npv?, pi? irp ?
Replied:
hi Rezinne Wilson
I assumed that initial investment is R 1 800 060, and created a solution in attached MS Excel Worksheet, If the initial cash outlay is different than R1 800 060 , you can replace this value in the attached WorkSheet and get your answers
NPV -$126,108
PI 0.93
IRR 8.75%
From these values we judge that this investment doesn't yield any profits and thus should be rejected
Acceptance Criteria for NPV
A project with positive NPV is accepted
Acceptance Criteria for Profitability index
A project with profitability index of greater than 1 is accepted
Acceptance Criteria for IRR
A project with IRR greater than the cost of capital is accepted
| A | B | |
|---|---|---|
| 1 | Rate | 12% |
| 2 | N | Cash Flows |
| 3 | 0 | -$1,800,060 |
| 4 | 1 | $500,000 |
| 5 | 2 | $650,000 |
| 6 | 3 | $480,000 |
| 7 | 4 | $400,000 |
| 8 | 5 | $200,000 |
| 9 | NPV | -$126,108 |
| 10 | PI | 0.93 |
| 11 | IRR | 8.75% |
| 12 |