Definition
The profitability index measures the present value generated per dollar of investment. PI > 1.0 indicates value creation (accept); PI < 1.0 indicates value destruction (reject). PI is particularly useful for ranking projects when capital is constrained, as it identifies the highest value per investment dollar rather than just the highest total NPV.
functions Formula
PI = PV of Future Cash Flows / Initial Investment
lightbulb Example
Initial investment is $100K, PV of future cash flows is $125K. PI = 1.25, meaning each dollar invested creates $1.25 in present value—a 25% excess return.
verified_user Key Points
- PI > 1.0 signals value creation
- Useful for capital rationing decisions
- Ranks projects by value per investment dollar
- Equivalent to NPV when projects are the same size