Akash Pgdm-profitability Index
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PROFITABILITY INDEX
DEFINITION Profitability Index approach measures the present value of returns per rupee invested. PI can be defined asPI=PV of cash inflows / PV of cash outflows Or PI=(NPV + Initial Investment) / Initial Investment This method is also known as Benefit-Cost Ratio(B/C Ratio).
ACCEPT-REJECT RULE PI > 1
The firm will accept the project.
PI = 1
The firm is indifferent to the project.
PI < 1
The firm will reject the project.
EVALUATION Example-1: a company invested Rs.20,000 for a project and expected NPV of that project is Rs.5,000. Profitability Index = (20,000 + 5,000) / 20,000 = 1.25 That means a company should perform the investment project because profitability index is greater than 1.
Example-2 : It is given that, • Investment = Rs.40,000 • life of the Machine = 5 Years Now, CFAT Year CFAT 1 18000 2 12000 3 10000 4 9000 5 6000
Continued….. NPV and PI at 10% : Year CFAT 1 18000 2 12000 3 10000 4 9000 5 6000
PV@10% PV 0.909 16362 0.827 9924 0.752 7520 0.683 6147 0.621 3726
Continued…. Now, Total present value = Rs. 43679 Investment = Rs. 40000 NPV = Rs. 3679 And, PI = 43679 / 40000 = 1.091 = >1 = Accept the project
NPV versus PI • In case of Accept Reject decision—Both are same • In case of evaluation of mutually exclusive proposals—PI is superior to NPV. ExampleProposal A Proposal B Cost Rs.1,00,000 Rs.80,000 PV of inflows Rs.1,20,000 Rs.1,00,000
NPV = PV of Inflows – Cost =Rs.20,000 PI = PV of Inflows / Cost PI(A) = 1.20 PI(B) = 1.25
• In case of Contradictory Decisions—NPV is superior to PI. ExampleProject A Project B Inetial outflows Rs. 1,50,000 Rs.1,10,000 PV of Inflows Rs.2,10,000 Rs.1,65,000 Now we have…………….. NPV Rs.60,000 Rs.55,000 PI 1.4 1.5
DEFINITION Profitability Index approach measures the present value of returns per rupee invested. PI can be defined asPI=PV of cash inflows / PV of cash outflows Or PI=(NPV + Initial Investment) / Initial Investment This method is also known as Benefit-Cost Ratio(B/C Ratio).
ACCEPT-REJECT RULE PI > 1
The firm will accept the project.
PI = 1
The firm is indifferent to the project.
PI < 1
The firm will reject the project.
EVALUATION Example-1: a company invested Rs.20,000 for a project and expected NPV of that project is Rs.5,000. Profitability Index = (20,000 + 5,000) / 20,000 = 1.25 That means a company should perform the investment project because profitability index is greater than 1.
Example-2 : It is given that, • Investment = Rs.40,000 • life of the Machine = 5 Years Now, CFAT Year CFAT 1 18000 2 12000 3 10000 4 9000 5 6000
Continued….. NPV and PI at 10% : Year CFAT 1 18000 2 12000 3 10000 4 9000 5 6000
PV@10% PV 0.909 16362 0.827 9924 0.752 7520 0.683 6147 0.621 3726
Continued…. Now, Total present value = Rs. 43679 Investment = Rs. 40000 NPV = Rs. 3679 And, PI = 43679 / 40000 = 1.091 = >1 = Accept the project
NPV versus PI • In case of Accept Reject decision—Both are same • In case of evaluation of mutually exclusive proposals—PI is superior to NPV. ExampleProposal A Proposal B Cost Rs.1,00,000 Rs.80,000 PV of inflows Rs.1,20,000 Rs.1,00,000
NPV = PV of Inflows – Cost =Rs.20,000 PI = PV of Inflows / Cost PI(A) = 1.20 PI(B) = 1.25
• In case of Contradictory Decisions—NPV is superior to PI. ExampleProject A Project B Inetial outflows Rs. 1,50,000 Rs.1,10,000 PV of Inflows Rs.2,10,000 Rs.1,65,000 Now we have…………….. NPV Rs.60,000 Rs.55,000 PI 1.4 1.5
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