Profitability Index is the ratio between the Present Value of Cash Inflows and the Present Value of Cash Outflows of a Project. Profitability Index is given by the below formula.
This ratio provides a common measure for investment of different magnitudes by expressing the PV of a project per unit investment. Note that If PI > 1, then the project is accepted or else rejected. Higher the PI, higher is the chances of the project being accepted.
Let us see how to calculate the Profitability Index using MS Excel (R).
There are three projects A, B and C. The Cash Inflow and Cash Outflow for next 10 years is given below. The interest rate for each of the project is taken as 10%.
The Profitability Index (PI) and Net Profitability Index (NPI) is calculated as below.
It is to be noted that Project C has higher PI and NPI and it can be selected.
One can also evaluate the projects with different interest rates. It is shown below.
It is to be noted in the above calculation that the interest rate for Project A is 12%, Project B is 13% and Project C is 15%. For Project B, the PI < 1 and NPI is Negative (Red Colour) and hence it has to be completely discarded (PI should always be Greater than 1 and NPI should be Positive).