- Trending Categories
- Data Structure
- Networking
- RDBMS
- Operating System
- Java
- iOS
- HTML
- CSS
- Android
- Python
- C Programming
- C++
- C#
- MongoDB
- MySQL
- Javascript
- PHP

- Selected Reading
- UPSC IAS Exams Notes
- Developer's Best Practices
- Questions and Answers
- Effective Resume Writing
- HR Interview Questions
- Computer Glossary
- Who is Who

# What is Profitability index in discounted cash flow technique in capital budgeting?

Profitability index (PI) measures the ratio between the present value of future cash flow and the initial investment. This is used for ranking investment projects and value created per unit of investment. PI is also known as profit investment ratio (PIR) or the value investment ratio (VIR).

PI >1 (project generates value and the company may go with the project).

PI=1 (project breaks even and the company is indifferent between proceeding or not proceeding with the project).

PI<1 (project destroys value and the company should not proceed with the project).

## Formula

Profitability index =$\frac{present\:value\:of\:future\:cash\:flows}{initial\:investment}$

$$=\frac{(Net\:present\:value\:+\:initial\:investment)}{initial\:investment}$$

## Example

Initial investment = Rs. 15,00,000/-, discounted rate = 10%

Year | Cash flow | Discounted Cash flow | |
---|---|---|---|

1 | 1,50,000 | 1,50,000 / (1.10) | 1,36,363.64 |

2 | 3,00,000 | 3,00,000 / (1.10)^2 | 2,47,933.88 |

3 | 5,00,000 | 5,00,000 / (1.10)^3 | 3,75,657.40 |

4 | 2,00,000 | 2,00,000 / (1.10)^4 | 1,36,602.69 |

5 | 6,00,000 | 6,00,000 / (1.10)^5 | 3,72,552.79 |

6 | 5,00,000 | 5,00,000 / (1.10)^6 | 2,82,236.97 |

7 | 1,00,000 | 1,00,000 / (1.10)^7 | 51,315.81 |

16,02,663.18 |

PV of future cash flows$\Rightarrow\frac{1602663.18}{1500000} \Rightarrow$1.0684 (>1)

Therefore, project generates value and the company may go with the project.

- Related Questions & Answers
- Define NPV in discounted cash flow technique in capital budgeting.
- What is Accounting Rate of Return in discounted cash flow technique in capital budgeting?
- Explain about payback period in non-discounted cash flow technique in capital budgeting.
- What is Capital Cash Flow method?
- What is Capital Budgeting?
- Explain discounted cash flow analysis in merger and acquisitions
- What is capital budgeting in finance?
- What is Payback Period in Capital Budgeting?
- What is Simulation Analysis in Capital Budgeting?
- What is Free Cash Flow?
- Why is Discounted Cash Flow (DCF) Method not suitable for valuing stock options?
- What is a cash flow hedge?
- What is free cash flow formula?
- How to use Capital Cash Flow in valuing a project?
- What is Free Cash Flow in Corporate Finance?