The Profitability Index (PI) is a capital budgeting tool used to evaluate the desirability of investment projects. It is determined by dividing the present value of expected future cash inflows by the initial investment cost.

A PI greater than one indicates a potentially profitable project. However, a PI of less than one suggests it may not be worth pursuing.

One of the strengths of PI is that it accounts for the time value of money, offering a more accurate measure than simple payback periods. It also plays a crucial role in facilitating easy comparison of projects with varying lifespans, empowering businesses to make better resource allocation decisions.

However, PI has limitations. It only considers the initial investment, ignoring any future capital that might be required. Additionally, it doesn't account for the scale of projects, meaning it could favor smaller projects with higher PIs over larger ones that could yield higher absolute returns.

While the Profitability Index is a valuable tool for evaluating investment opportunities, its true power is realized alongside other financial metrics. This comprehensive approach provides a holistic view of the investment, reassuring the soundness of the investment decisions made.

From Chapter 7:

article

Now Playing

7.18 : Profitability Index

Capital Budgeting

46 Views

article

7.1 : Introduction to Capital Budgeting

Capital Budgeting

173 Views

article

7.2 : Basics of Investment Decision-making

Capital Budgeting

110 Views

article

7.3 : Importance of Capital Budgeting

Capital Budgeting

73 Views

article

7.4 : Advantages and Limitations of Capital Budgeting

Capital Budgeting

243 Views

article

7.5 : Capital Budgeting Techniques

Capital Budgeting

118 Views

article

7.6 : Payback

Capital Budgeting

72 Views

article

7.7 : Payback Period

Capital Budgeting

38 Views

article

7.8 : Discounted Payback Period

Capital Budgeting

54 Views

article

7.9 : Net Present Value

Capital Budgeting

118 Views

article

7.10 : Net Present Value Method

Capital Budgeting

124 Views

article

7.11 : Decision-making Through Net Present Value

Capital Budgeting

43 Views

article

7.12 : Internal Rate of Return

Capital Budgeting

34 Views

article

7.13 : Calculating Internal Rate of Return

Capital Budgeting

27 Views

article

7.14 : Decision-making Through Internal Rate of Return

Capital Budgeting

32 Views

See More

JoVE Logo

Privacy

Terms of Use

Policies

Research

Education

ABOUT JoVE

Copyright © 2025 MyJoVE Corporation. All rights reserved