The formulas
- PV of inflows = sum of CF_t / (1 + r)^t for t = 1 to 6
- Profitability index = PV of inflows / initial investment
- NPV = PV of inflows - initial investment
How it works
The profitability index divides the present value of future cash flows by the money spent today. A value above 1.0 means the project returns more than its cost in present value terms, which is the same signal as a positive NPV.
The index earns its place when capital is rationed. If you can fund only some projects, rank them by profitability index and fund down the list until the budget runs out. NPV ranks by dollar size, the index ranks by value per dollar. Blank years count as zero.
Illustrative figures only. Check the result against your firm's methodology before relying on it.
Common questions
Do PI and NPV ever disagree?
On accept or reject, no. On ranking, yes: a large project can have the higher NPV and the lower index.
Which discount rate do I use?
The required return for the project risk, often the WACC for an average-risk project.
Where are cash flows timed?
At the end of each year. The initial investment is at time zero.
Formulas on this page are the standard definitions.
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