A profitability index (PI), alternatively referred to as a profit investment ratio or a value investment ratio, is a

method for discerning the relationship between the costs and benefits of investing in a possible project. It
calculates the cost/benefit ratio of the present value (PV) of a projects future cash flow over the price of the
projects initial investment. This formula is commonly written as PI = PV of future cash flows initial
investment. The figure this formula yields helps investors decide on whether or not a project is financially
attractive enough to pursue.

A profitability index of 1 designates the lowest measure by which it is logically acceptable to pursue a project.
A value lower than 1 suggests that the project's possible value is lower than the initial investment. This means
that the investor does not make a profit and should not invest in the project. A value exceeding 1 indicates
financial gain, and as the number goes up, the investment becomes more attractive.

Aside from individual cases, many companies and investors use the profitability index as a way of ranking a
group of potential projects. Any project below one is excluded from the list altogether; those with a PI rating of
one or higher are considered. The profitability index is thought to be useful for this task because it allows for
the measurement and comparison of two or more separate projects, each of which require completely different
investment amounts.

The number the profitability index yields projects the amount returned on each dollar invested. So, if the
profitability index yields a 1.5, an investor can expect to get a return of $1.50 US Dollar (USD) for each dollar
invested. Alternatively, a profitability index yields a 0.9, an investor can expect to get $0.90 USD back for
each dollar spent, which results in negative returns.

The profitability index is related to another common financial formula called the net present value (NPV)
indicator. These two formulas are often confused because they are both used for a similar purpose. However,
while the profitability index measures the relative value of an investment, the net present value indicator
measures the absolute value of an investment.

The profitability index is considered somewhat limited, in that it would instruct us to accept all investments
above 1. However, it assumes that investors do not have to ration their capital and thus can invest as much as
needs to be invested. However, if capital is scarce, an investor needs to consider the size of the investment
itself, as investing large amounts of capital in just one project involves a large amount of risk.

What is the advantages and disadvantages of

profitability index?
In: C Programming, Visual Basic Programming [Edit categories]

Answer:

What is the advantages and disadvantages of profitability

index?"
Profitability Index
Advantages

Tells whether an investment increases the firm's value

Considers all cash flows of the project

Considers the time value of money

Considers the risk of future cash flows (through the cost of capital)

Useful in ranking and selecting projects when capital is rationed

Disadvantages

Requires an estimate of the cost of capital in order to calculate the profitability index

May not give the correct decision when used to compare mutually exclusive projects

Profitability index (PI), also known as profit investment ratio (PIR) and value investment
ratio (VIR), is the ratio of payoff to investment of a proposed project. It is a useful tool for
ranking projects because it allows you to quantify the amount of value created per unit of
investment.

The ratio is calculated as follows:

Assuming that the cash flow calculated does not include the investment made in the project, a
profitability index of 1 indicates breakeven. Any value lower than one would indicate that the
project's PV is less than the initial investment. As the value of the profitability index increases,
so does the financial attractiveness of the proposed project.

Rules for selection or rejection of a project:

If PI > 1 then accept the project

If PI < 1 then reject the project