Profitability Index Calculation Examples Help

Profitability Index Calculation Examples, Illustrations, Concept, Sample help Online


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Concept of Profitability Index Calculation Examples

Profitability index is also known as profit investment ratio. It is a type of financial tool which us whether an investment should be accepted or rejected. It helps in identifying the relationship between the costs and benefits of a proposed project. Profitability index can be calculated using the following formula
Profitability Index
= Present Value of Future Cash Flows/Initial Investment Required
= 1 + Net Present Value/Initial Investment Required

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Profitability Index Calculation Examples Explanation

Let’s understand the concept of profitability index with help of an example.
Example: A company is proposed a project at a cost of $500000which is expected to generate future net cash flows with a present value of $650000 million. Calculate the profitability index.
Profitability Index = PV of Future Cash Flows / Initial Investment Required
Profitability Index = $6500000 / $500000 = 1.3
Net Present Value = PV of Net Future Cash Flows − Initial Investment Required
Net Present Value = $650000-$500000 = $150000.
We can calculate Profitability Index using the above information as follows
Profitability Index = 1 + (Net Present Value / Initial Investment Required)
Profitability Index = 1 + $150000/$500000 = 1.3
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