## Profitability index worked example

Profitability index is sometimes called benefit-cost ratio too and is useful in capital rationing since it helps in ranking projects based on their per dollar return. Example 1: Company C is undertaking a project at a cost of N50 million which is expected to generate future net cash flows with a present value of N65 million. Calculate the A profitability index of 1 indicates breaking even, which is an indifferent result for potential investors. If the result is less than 1.0, logic suggests that the investment should be avoided, as the project's costs outweigh the potential profits.

Profitability Index = (PV of future cash flows) ÷ Initial investment. Or = (NPV + Initial investment) ÷ Initial Investment: As one would expect, the NPV stands for the Net Present Value of the initial investment. Profitability Index Calculation. Example: a company invested \$20,000 for a project and expected NPV of that project is \$5,000. In the example above, the project has a \$20,000 NPV, and in general if a profitability index is greater than 1, the NPV will be positive. Also, when the profitability index is less than 1, the net present value is usually negative. The profitability index demonstrates the potential profitability of a company as a ratio. What is the Profitability Index? The Profitability Index (PI) measures the ratio between the present value of future cash flows and the initial investment. The index is a useful tool for ranking investment projects and showing the value Value Added Value Added is the extra value created over and above the original value of something. It can apply to products, services, companies, management, and other areas of business. Profitability Index is the ratio of the present value of future cash flows of the project to the initial investments in the project. This index helps in cost-benefit analysis of investment projects and helps them rank in order of the best return on initial investments. Profitability Index = 1 + (Net Present value / Initial investment) Steps to Calculate Profitability Index Step #1: Firstly, the initial investment in a project has to be assessed based on the project requirement in terms of capital expenditure for machinery & equipment and other expenses which are also capital in nature. Profitability index is sometimes called benefit-cost ratio too and is useful in capital rationing since it helps in ranking projects based on their per dollar return. Example. Company C is undertaking a project at a cost of \$50 million which is expected to generate future net cash flows with a present value of \$65 million. Calculate the profitability index. Solution Profitability Index = PV of Future Net Cash Flows / Initial Investment Required Profitability Index = \$65M / \$50M = 1.3

## In the example above, the project has a \$20,000 NPV, and in general if a profitability index is greater than 1, the NPV will be positive. Also, when the profitability index is less than 1, the net present value is usually negative. The profitability index demonstrates the potential profitability of a company as a ratio.

The profitability index formula does look very simple. All you need to do is to find out the present value of future cash flows and then divide it by the initial  20 Apr 2019 Profitability Index is a capital budgeting tool used to rank projects based on their profitability. It is calculated by dividing present value of all cash  24 Jul 2013 Example: a company invested \$20,000 for a project and expected NPV of that project is \$5,000. Profitability Index = (20,000 + 5,000) / 20,000 =  12 Dec 2019 For example, if a project costs \$1,000 and will return \$1,200, it's a "go." PI vs. NPV. The profitability index rule is a variation  27 Jan 2020 The method divides the projected capital inflow by the projected capital outflow to determine the profitability of a project. As indicated by the  Learn how the Profitability Index can help you measure the operational From it, it is possible to evaluate if the adopted strategies are working well and what In this way, we see that the example given has a profitability of 169.68%, that is,  23 Oct 2016 Follow along with a simple example based on a small lemonade stand.

### Follow along with a simple example based on a small lemonade stand. Calculating a profitability index The next step is to use the information from the net present value calculation to

7 Sep 2015 For example, if annual interest rate is 10%, then the NPV of a \$110 in a year from now A profitability index of 1.0, which is discounted ROI of zero, When working on complex projects with past and future cash flows, it is not  9 Apr 2015 For example, “revenue” isn't a cash-based number: A company can record revenue at a point in time) and are included in working capital — funds used in the net present value, internal rate of return, and profitability index.

### What is the Profitability Index? The Profitability Index (PI) measures the ratio between the present value of future cash flows and the initial investment. The index is a useful tool for ranking investment projects and showing the value Value Added Value Added is the extra value created over and above the original value of something. It can apply to products, services, companies, management, and other areas of business.

Video created by Emory University for the course "Finance for Non-Financial Managers". This module will demonstrate a variety of investment decision  accounts payable) of 5% of revenues, with the investments in working capital being made at Profitability Index (PI) = NPV/Initial Investment. □ In the example  7 Sep 2015 For example, if annual interest rate is 10%, then the NPV of a \$110 in a year from now A profitability index of 1.0, which is discounted ROI of zero, When working on complex projects with past and future cash flows, it is not  9 Apr 2015 For example, “revenue” isn't a cash-based number: A company can record revenue at a point in time) and are included in working capital — funds used in the net present value, internal rate of return, and profitability index. Profitability Index = (PV of future cash flows) ÷ Initial investment. Or = (NPV + Initial investment) ÷ Initial Investment: As one would expect, the NPV stands for the Net Present Value of the initial investment. Profitability Index Calculation. Example: a company invested \$20,000 for a project and expected NPV of that project is \$5,000.

## The profitability index helps make it possible to directly compare the NPV of one project to the NPV of another to find the project that offers the best rate of return. Calculating net present value of a lemonade stand. Suppose you have the opportunity to start a lemonade stand for \$100.

Profitability ratios focus on a company’s return on investment in inventory and other assets. These ratios basically show how well companies can achieve profits from their operations. Investors and creditors can use profitability ratios to judge a company’s return on investment based on its relative level of resources and assets. Profitability Index is a capital budgeting tool used to rank projects based on their profitability. It is calculated by dividing present value of all cash inflows by the initial investment. Projects with higher profitability index are better.

7 Sep 2015 For example, if annual interest rate is 10%, then the NPV of a \$110 in a year from now A profitability index of 1.0, which is discounted ROI of zero, When working on complex projects with past and future cash flows, it is not  9 Apr 2015 For example, “revenue” isn't a cash-based number: A company can record revenue at a point in time) and are included in working capital — funds used in the net present value, internal rate of return, and profitability index. Profitability Index = (PV of future cash flows) ÷ Initial investment. Or = (NPV + Initial investment) ÷ Initial Investment: As one would expect, the NPV stands for the Net Present Value of the initial investment. Profitability Index Calculation. Example: a company invested \$20,000 for a project and expected NPV of that project is \$5,000. In the example above, the project has a \$20,000 NPV, and in general if a profitability index is greater than 1, the NPV will be positive. Also, when the profitability index is less than 1, the net present value is usually negative. The profitability index demonstrates the potential profitability of a company as a ratio. What is the Profitability Index? The Profitability Index (PI) measures the ratio between the present value of future cash flows and the initial investment. The index is a useful tool for ranking investment projects and showing the value Value Added Value Added is the extra value created over and above the original value of something. It can apply to products, services, companies, management, and other areas of business. Profitability Index is the ratio of the present value of future cash flows of the project to the initial investments in the project. This index helps in cost-benefit analysis of investment projects and helps them rank in order of the best return on initial investments. Profitability Index = 1 + (Net Present value / Initial investment) Steps to Calculate Profitability Index Step #1: Firstly, the initial investment in a project has to be assessed based on the project requirement in terms of capital expenditure for machinery & equipment and other expenses which are also capital in nature.