Plain definition
Profitability index, or PI, divides the present value of future project cash inflows by the initial investment. A PI above 1.0 means that discounted inflows exceed the outlay and the project has positive NPV at the chosen rate; a PI below 1.0 means they do not. It can help rank divisible investments when capital is rationed because it shows value per unit of capital committed.
It does not replace NPV. PI can favour a small project with a high ratio over a larger project that creates more total value, and it can mislead when projects are indivisible or mutually exclusive. Its reliability also depends entirely on the same cash-flow and discount-rate discipline required for NPV.
Illustrative example
Monetary examples use Saudi riyals (SAR). The same principles apply in other currencies.
Suppose a project requires now and its future cash inflows have a present value of . The PI is 1.125: divided by . The project therefore creates of NPV at that rate, before considering capacity, risk, or a competing use of the capital.
If another project needs and has a PI of 1.08, it may add more SAR even though its index is lower. A company with enough capital should compare total NPV; a company with a hard capital limit can use PI as one input to build a feasible portfolio.
| Present value of future inflows | |
|---|---|
| Initial investment | |
| Profitability index |
PI is meaningful only when the numerator and denominator use the same project boundary and timing convention.
Why it matters
The index makes capital efficiency visible, which can be useful when a business has many potential uses of limited cash. The danger is treating a ratio as a complete ranking when scale, timing, and operational dependencies differ.
Practical consequence
Calculate the present value of incremental inflows and identify the initial cash outlay included in the denominator. Reconcile PI with NPV: PI minus 1, multiplied by the initial outlay, should equal NPV in the simple single-outlay case. Then test whether projects can actually be split, combined, and delivered within the same cash and execution limit.