The Profitability Index (PI) is calculated by dividing the present value of future cash flows by the initial investment. It's a valuable tool for evaluating the attractiveness of a project or investment.
PI Formula and Calculation
The formula for calculating the Profitability Index is:
PI = Present Value of Future Cash Flows / Initial Investment
Example:
Let's consider an example based on the provided reference:
- Present Value of Future Cash Flows: ₹13,00,00,000
- Initial Investment: ₹10,00,00,000
Using the formula:
PI = ₹13,00,00,000 / ₹10,00,00,000 = 1.3
Interpretation:
A PI value greater than 1 generally indicates that the investment is worthwhile, as the present value of future cash flows exceeds the initial investment. In the example above, a PI of 1.3 suggests that the investment is potentially a good decision. A PI of less than 1 would suggest the investment is not financially beneficial.
Significance of PI
The Profitability Index helps in:
- Project Selection: Choosing between multiple investment opportunities.
- Resource Allocation: Deciding where to allocate capital for maximum returns.
- Investment Decision: Determining whether a project is financially viable.
