1. What is the Profitability Index?

The Profitability Index (PI) is a capital budgeting tool that measures the relationship between the costs and benefits of a proposed project. It's calculated by dividing the present value of future cash flows by the initial investment and adding 1.

2. How Does the Calculator Work?

The calculator uses the Profitability Index formula:

Where:

• \( NPV \) — Net Present Value (USD)
• \( Initial\ Investment \) — Initial project cost (USD)

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

3. Importance of PI Calculation

Details: The Profitability Index helps investors and managers compare different projects and prioritize those with the highest potential return relative to their cost.

4. Using the Calculator

Tips: Enter the Net Present Value (can be positive or negative) and Initial Investment (must be positive). The calculator will compute the PI ratio.

5. Frequently Asked Questions (FAQ)

Q1: What does a PI 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.

Q2: How does PI differ from NPV?
A: While NPV gives absolute dollar value, PI provides a relative measure of profitability per dollar invested.

Q3: When should PI be used over other metrics?
A: PI is particularly useful when comparing projects of different sizes or when capital is constrained.

Q4: What are the limitations of PI?
A: PI doesn't account for project scale and may favor smaller projects with high returns but low absolute value.

Q5: How does PI relate to IRR?
A: Projects with PI > 1 typically have IRR > discount rate, but PI provides more specific information about value created per dollar invested.