Investment appraisal Updated November 2026

Profitability index

The profitability index is PI = PV of future cash inflows / initial investment, which equals 1 + NPV / investment. A PI above 1 means positive NPV, so accept. It shows value created per unit invested, which makes it the right tool for ranking projects when capital is limited.

Syntax

PI = PV of inflows / initial investment = 1 + NPV / investment

Part	What it is
`PV of inflows`	Sum of discounted future cash flows (excluding the investment)
`initial investment`	The outlay at time 0, as a positive number

Examples

Invest 1,000; inflows 500 a year for 3 years; r = 10%
PV of inflows = 1,243.43
PI = 1,243.43 / 1,000

Result: PI = 1.24 (accept)

Excel: =NPV(10%, 500, 500, 500) / 1000

Invest 10,000; inflows 3,000, 4,000, 5,000; r = 8%
PV of inflows = 10,176.29
PI = 10,176.29 / 10,000

Result: PI = 1.02 (accept, barely)

Invest 5,000; inflows 2,000 a year for 3 years; r = 12%
PV of inflows = 4,803.66
PI = 4,803.66 / 5,000

Result: PI = 0.96 (reject)

Common mistakes

Dividing NPV by the investment and reading it as PI: NPV / investment is PI minus 1, so 0.24 means a PI of 1.24.
Including the initial outlay in the numerator, which gives NPV / investment instead of the index.
Ranking by PI when projects are mutually exclusive and capital is unlimited; then the one with the higher NPV wins even if its PI is lower.

Practice Profitability index

These drills check your answer on live data, free, no account needed.

Profitability indexA project costs $25,000 today and returns $16,500, $14,500 and $13,500 at the end of years 1 to 3. At 8.75%, what is its profitability index, to 2 decimals?
Net present valueA project costs $25,000 today and returns $15,000, $13,000 and $12,000 at the end of years 1 to 3. At a cost of capital of 9.75%, what is its net present value? (Enter a negative number if NPV is below zero.)

Questions

When should I use the profitability index instead of NPV?

When you cannot fund every positive-NPV project. Ranking by PI picks the combination that creates the most value per unit of scarce capital.

What does a PI of 1.24 mean?

Every 1.00 invested returns 1.24 in present value, so the project creates 0.24 of value per unit invested.

NPV (net present value)Net present value is the sum of discounted cash flows minus the initial investment. Examples at 10% and 8%, the accept rule, Excel NPV and the sign mistake.
IRR (internal rate of return)The IRR is the discount rate that makes NPV zero. How to find it by trial, what Excel IRR returns, worked examples, the accept rule and where IRR fails.
Payback periodPayback period is the time it takes cumulative cash inflows to equal the initial investment. Formula for even and uneven cash flows, examples, interpolation.
Present valueHow to calculate present value with PV = FV / (1 + r)^n, what discounting means, examples with yearly and quarterly rates, the Excel PV function and mistakes.