Profitability Index Financial Calculator

Profitability Index Formula:

\[ PI = \frac{\text{PV of Cash Inflows}}{\text{PV of Cash Outflows}} \]

Profitability Index (PI):

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1. What is Profitability Index?

The Profitability Index (PI) is a financial metric that measures the ratio between the present value of cash inflows and the present value of cash outflows. It helps evaluate the attractiveness of an investment opportunity.

2. How Does the Calculator Work?

The calculator uses the Profitability Index formula:

\[ PI = \frac{\text{PV of Cash Inflows}}{\text{PV of Cash Outflows}} \]

Where:

PV of Cash Inflows — Present value of all expected future cash inflows (USD)
PV of Cash Outflows — Present value of all expected future cash outflows (USD)

Interpretation:

PI > 1 indicates a potentially profitable investment
PI = 1 indicates break-even
PI < 1 indicates a potentially unprofitable investment

3. Importance of PI Calculation

Details: The Profitability Index is crucial for capital budgeting decisions, allowing comparison of different investment projects regardless of their scale. It considers the time value of money and helps prioritize projects when capital is limited.

4. Using the Calculator

Tips: Enter the present value of all expected cash inflows and outflows in USD. Both values must be positive numbers. The calculator will compute the ratio (unitless) between these values.

5. Frequently Asked Questions (FAQ)

Q1: How is PI different from NPV?
A: While both consider time value of money, NPV gives absolute dollar value while PI provides a relative measure (ratio) of value created per unit of investment.

Q2: What are the advantages of using PI?
A: PI allows comparison of projects of different sizes and is particularly useful when capital is constrained (capital rationing situations).

Q3: What are the limitations of PI?
A: PI may give misleading results for mutually exclusive projects with different scales. It also requires accurate estimation of future cash flows.

Q4: Should PI be used alone for investment decisions?
A: No, it should be used in conjunction with other metrics like NPV, IRR, and payback period for comprehensive analysis.

Q5: How does discount rate affect PI?
A: Higher discount rates reduce present value of future cash flows, potentially lowering PI. The discount rate should reflect the project's risk.