Question

20. What is the PI (Profitability Index) ratio for the project? Will you accept the project based on the PI ratio?

Answer 1

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

PI formula ;

method : 1

PI = PV of future cash flows/initial investment required

method 2 :

PI = 1+(NPV/initial investment required)

NPV=PV of future cash flow-initial investment required

Example :

ABC company has decided to invest in a project for which the initial investment would be $100 million. As they are considering whether its good deal to invest into, they have found out that the present value of future cash flow of this project is 130 million. is it a good project or not?

PI = PV of future cash flow/initial investment required

=$130 million/$100 million

PI = 1.3

if you apply method 2 for your calculation, you will get same answer.

1. if the index is more than 1, then the investment is worthy .

2.if the index is less than 1, then its better to step back and look for other oppurtunities

3. if the index is equal to 1, then its an neutral project. don't invest