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Profitability index

The formula for the index of profitability - the assistant to the investor

To invest or not to invest - that is the question! To know the answer, the safest way is to calculate in advance the profitability index. And then you will not blame themselves for the wrong investment in the notoriously unprofitable enterprise.

Investment profitability index

So what is the profitability index? It is a measure of payback of the investment project, its profitability. In order to properly dispose of investments and to reduce risks to a minimum you need to know the order of calculation of the index of profitability.

The profitability index pi is the ratio of the total of the discounted income and the amount of the original investment.

Index formula:

PI = PV / I

where PV - discount income, and I is the sum of investment expenses, cash investments in the project.

That project was recognized as a potentially effective, the value of PI must be greater than one.

 The formula for profitability index

This formula applies only to the initial stage of the project. There is a more accurate formula for determining the profitability of already existing enterprises:

where NCFi - net cash flow for the period i, Inv - initial investment r is the discount rate (the cost of capital raised for the investment project).

 The index of profitableness of investments

This formula will calculate the rate of return on the initial stage and determine confirmed whether the data earlier prediction.

Determination of the profitability index gives more precise compared to net present value. This applies in cases when the investor has a choice of several objects for investments. It is PI will show the level of profitability of each of the possible, allowing to make the right decision.

The calculation of the formula has one disadvantage. Even in the case when the PI > 1 risk still exists. The formula does not account for lost time on the project. The change of the refinancing rate of the Central Bank may increase the cost of capital, which will lead to negative discounting.

Discounted profitability index

 Formula discounted profitability index

Under the discounted income understand the net present value. Discounted index can be defined as a view of investment project payback  is equal to the sum of all investment flows divided by the present value of the investment consumption.

DPI - yield index discounted costs; CFt - cash flow in the period t; It is the sum of investment costs in the period t; r - barrier discount rate); n - total number of intervals (steps periods) t = 0, 1, 2, ..., n.

The more discounted profitability index (bits) dp1, the better the project. But as PI it must be greater than one.

The disadvantage of this formula, which should be considered when using it, is that you cannot compare cash flows from different periods. That is, the calculations are not objective and contain errors.

The use of additional instruments to study the investment climate will give you peace of mind and confidence in the decision. Invest intelligently and then your money will work for you.


Read also: - Profit - Inflation - Gross profit as a method of estimation of efficiency of production