Learning Outcomes
- Calculate the profitability index
The profitability index (PI) is a measure of a project’s or investment’s attractiveness. Compared to most calculations, the profitability index is a simple calculation:
The present value of future expected cash flows
Divided by
The initial investment amount in the project.
For the JuxtaPos project, the present value of future expected cash flows at 15% was:
| Year | Factor | Amount | Total |
|---|---|---|---|
| Year 1 | $ 60,000 | times the factor of 0.8700 | = $52,200 |
| Year 2 | 60,000 | 0.7560 | $ 45,360 |
| Year 3 | 55,000 | 0.6580 | $ 36,190 |
| Year 4 | 55,000 | 0.5720 | $ 31,460 |
| Year 5 | 50,000 | 0.4970 | $ 24,850 |
| Year 6 | 65,000 | 0.4320 | $ 28,080 |
| Total present value of cash inflows | Single Line$218,140 |
The initial investment was $230,000, so the PI is 218,140 / 230,000 = 0.95
As a general rule of thumb, a PI greater than 1.0 is deemed as a good investment, with higher values corresponding to more attractive projects. As we assess our capital needs and constraints as we compare various options, some of which are mutually exclusive, we would normally choose those with the highest PIs (absent other qualitative factors which have probably already been taken into account in the screening process).
Now check your understanding of the profitability index.
