Question

Profitability Index NPV/Initial Investment

Can you please give me a breakdown how to figure out NPV/Intitial investment. If you cab please just show me an example how to figure it out.

On an sheet, just want an example and a breakdown on how you came up with it. Thanks

Answer 1

Profitability Index is the ratio of the present value of future cash flows of the project to the initial investments in the project. This index helps in cost benefit analysis of investment projects and helps them rank in order of the best return on initial investments.

• If the index is more than 1, then the investment is worthy because then you may earn back more than you invest in.
• If the index is less than 1, then it’s better to step back and look for other opportunities. Because when PI is less than 1 that means you would not get back the money you would invest. Why bother to invest at all?

If the index is equal to 1, then it’s an indifferent or neutral project. You shouldn’t invest in the project until and unless you consider it better than other projects available during the period. If you find that the PI of all other projects to be negative, then consider investing in this project

Consider the following Example.

Investment	$40,000
Life	5 Years
		PV Factor @10%
Year	Cashflows		PV
1	18000	0.909	16362
2	12000	0.827	9924
3	10000	0.752	7520
4	9000	0.683	6147
5	6000	0.621	3726
		Total PV	43679
		(-) Investment	40,000
		NPV	3,679
		PI	1.092
		PI > 1
		So Accept the project

We have considered WACC as 10%. We can get the PV factor for 10% from the PV Table.

PI = 43679/40000 = 1.092

NPV = 43679- 40000 = $3679