Profitability Index (PI)
The Profitability Index (PI), also known as the Profit Investment Ratio (PIR), is a capital budgeting tool that measures the potential profitability of a project by comparing the present value of expected future cash flows to the initial investment. It is calculated as the present value of cash inflows divided by the initial outlay. A PI greater than 1 indicates that a project is expected to generate more value than its cost, making it a potentially profitable investment.
Example
A company evaluates a new project with a PI of 1.5, indicating that the project’s present value of cash inflows is 1.5 times greater than the initial investment, suggesting profitability.
Key points
• A measure of a project’s profitability relative to its initial investment.
• Calculated by dividing the present value of cash inflows by the initial outlay.
• A PI greater than 1 indicates a potentially profitable project.
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