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Data Source and Methodology
All calculations are based rigorously on formulas and data provided by authoritative financial resources. Investopedia.
"All calculations are strictly based on the formulas and data provided by this source."
The Formula Explained
PI = \frac{Present\ Value\ of\ Future\ Cash\ Flows}{Initial\ Investment}
Glossary of Terms
- Present Value of Future Cash Flows: The current worth of all future cash flows expected from the investment.
- Initial Investment: The cost associated with starting the investment.
- Profitability Index (PI): A ratio that compares the present value of cash flows to the initial investment.
How It Works: A Step-by-Step Example
Suppose you expect future cash flows to be valued at $50,000, and the initial investment is $30,000. The PI is calculated as follows:
PI = \frac{50000}{30000} = 1.67.
This indicates that the project generates $1.67 for every $1 invested, which is generally considered a good investment.
Frequently Asked Questions (FAQ)
What is the Profitability Index?
The Profitability Index is a financial tool used to determine the potential returns of an investment compared to its costs.
Why is the PI important?
It helps in evaluating which projects to invest in by comparing their returns relative to investment costs.
What is a good PI value?
A PI greater than 1 indicates a potentially profitable investment.
How do I calculate the PI?
Divide the present value of future cash flows by the initial investment.
Can the PI be negative?
No, a negative PI indicates a loss, which means the project's cash flows are less than the initial investment.