1. What is the Profitability Index?

The Profitability Index (PI), also known as the profit investment ratio (PIR) or value investment ratio (VIR), is a capital budgeting technique that measures the relationship between the present value of cash inflows and the present value of cash outflows of a project.

2. How Does the Calculator Work?

The calculator uses the Profitability Index formula:

Where:

• \( PV \text{ Inflows} \) — Present value of future cash inflows (USD)
• \( PV \text{ Outflows} \) — Present value of initial investment outflows (USD)

Interpretation: A PI greater than 1 indicates a potentially profitable investment, while a PI less than 1 suggests the project may not be worthwhile.

3. Importance of Profitability Index

Details: The Profitability Index is crucial for investment decision-making as it helps compare projects of different scales, ranks investment opportunities, and considers the time value of money in capital budgeting decisions.

4. Using the Calculator

Tips: Enter the present value of cash inflows and outflows in USD. Both values must be positive numbers. The calculator will compute the Profitability Index ratio.

5. Frequently Asked Questions (FAQ)

Q1: What does a Profitability Index of 1.5 mean?
A: A PI of 1.5 means that for every dollar invested, the project is expected to return $1.50 in present value terms, indicating a profitable investment.

Q2: How is PI different from NPV?
A: While NPV gives the absolute dollar value of a project's profitability, PI provides a relative measure (ratio) that's useful for comparing projects of different sizes.

Q3: When should PI be used over other investment appraisal methods?
A: PI is particularly useful when capital is rationed and you need to compare projects with different investment requirements to maximize returns per dollar invested.

Q4: What are the limitations of the Profitability Index?
A: PI may give misleading results for mutually exclusive projects with different scales, and it requires accurate estimation of cash flows and discount rates.

Q5: How should mutually exclusive projects be evaluated using PI?
A: While PI is useful for ranking projects, for mutually exclusive projects, it's often best to combine PI analysis with NPV to make the final decision.