How this calculator works
The profitability index puts a project's benefits and costs on the same scale. Take the present value of every future cash flow, using the discount rate to translate later money into today's dollars, then divide by the initial investment. An index above one means the project returns more value than it costs; below one means it destroys value at that discount rate; exactly one is break-even. Because it is a ratio, it ranks projects of different sizes and is useful when capital is limited and you need to know which dollars work hardest. It does not show the absolute size of the gain, so pair it with net present value.
Formula
Profitability index = present value of future cash flows / initial investment. Net present value = present value of future cash flows - initial investment. Present value of year t = cash flow_t / (1 + r)^t, where r is the discount rate.
Worked example
A project costs $100,000 and its future cash flows have a present value of $150,000. The profitability index is 1.5 and net present value is $50,000. With yearly cash flows of $30,000, $40,000, $50,000, $60,000 and $70,000 at a 10% discount rate, the present values total $182,341.62, giving an index of 1.8234 and a net present value of $82,341.62. The first three flows alone total $97,896.32 and give an index of 0.9790, below one.
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Frequently asked questions
What discount rate should I use?
Use the return the business could earn on another project of similar risk, often its weighted average cost of capital. A higher rate makes distant cash flows count for less and lowers the index.
Can the index rank projects when money is limited?
Yes, that is its main advantage. When you cannot fund every positive project, choosing the highest index first tends to make the most of a fixed budget. The ranking assumes the projects are independent and can be scaled or repeated.
Why is the index missing in some cases?
It divides by the initial investment, so the investment must be above zero. A project that costs nothing has no meaningful index even if it generates cash.