The Profitability Index (PI), also known as the profit investment ratio (PIR) or value investment ratio (VIR), measures the ratio between the present value of free cash flows (FCF) and the capital investment initially made on a project. Financial analysts can use this index to compare and rank investment projects based on the per unit value created.

Profitability Index Formula

The formula for calculating the PI is: Profitability Index = Present Value of Future Cash Flows / Initial Investment or Profitability Index = (Net Present Value + Initial Investment) / Initial Investment

Interpretation of PI

When a project has a PI >1, the project creates value and therefore a company should proceed with it. When a project has a PI =< 1, the project does not necessarily create value and the company should carefully consider whether or not to proceed with the project. Generally speaking, the higher the PI the more attractive the investment to investors.

Pros and Cons of Profitability Index

PI tells a company whether an investment would create or destroy value for the company. It is a good metric to use because it accounts for the time value and risk of future cash flows by using the cost of capital as the discount rate. In addition, it is frequently used to rank projects and therefore choose the optimal one. Nonetheless, the calculation of PI requires the use of an estimated cost of capital. When projects are mutually exclusive (meaning they require different initial investments), PI does not help companies identify the right decision.

Other Useful Resources

Read CFI's guide on PI to learn more about the topic, implication, examples of calculating profitability index. Also feel free to browse around CFI Marketplace to find other useful accounting templates.
Reviews Add a review
No reviews yet

More From Corporate Finance Institute®

Browse our top rated business templates. See All
REIT Financial Model Template
This REIT financial model template acts as a guideline for modeling a real estate investment trust (REIT). This model will…
Energy Industry Comps Template Energy Industry Comps Template
This energy industry comps template provides a guideline and example of what a comparables universe would look like for a…
Financial Institution Dividend Discount Model
The financial institution dividend discount model uses future dividends to find the implied share price. This model is based on…
Loan Payment Calculator
The loan payment calculator allows users to determine the principal and interest payment each month until the full balance of…
DDM - Excel Dividend Discount Model Template
The dividend discount model template allows investors to value a company base on future dividend payments. This is based on…
Non-directional trading strategy template Non-directional Trading Strategies Template
The non-directional trading strategies template allow users to determine the profit when buying options. This template focuses on non-directional strategies…
See All