Profitability Index Calculator

Value per unit of money committed

You put money into something. The money it will produce, discounted back to today, comes to some other figure. The profitability index is the second divided by the first.

Profitability index = Present value of future cash flows / Initial investment

So an index of 1.23 says every unit of money you commit comes back as 1.23 units of present value. Twenty three paise of gain per rupee invested.

The decision rule is about as simple as decision rules get.

Two boxes, one number. What makes it interesting is not the arithmetic but what it does that a plain net present value cannot, and there is a section on that below.

It is net present value, restated

The profitability index and net present value are not rival opinions about a project. They are the same fact in different units, and the relationship between them is exact.

Net present value is the present value of the cash flows minus what you put in. The profitability index is the same two numbers divided rather than subtracted. Which gives:

Profitability index = 1 + (NPV / Initial investment)

And therefore, always and without exception, an index above 1 means a positive NPV, and an index below 1 means a negative one. The two can never disagree about whether a single project is worth doing.

What they differ on is what they emphasise. NPV tells you the size of the value created, in money. The index tells you the rate at which capital was converted into value, as a ratio.

A project creating 69,018 of NPV on a 300,000 investment and one creating 69,018 on a 3,000,000 investment have identical NPVs and very different indices, 1.23 against 1.02. If money is unlimited both are worth doing. If it is not, the difference matters enormously.

Three hundred thousand in, how much out

An investment costs 300,000 up front and produces five annual receipts of 90,000, which at a 7 percent discount rate are worth 369,017.77 today.

369,017.77 divided by 300,000 is 1.23.

So every rupee committed comes back as 1.23 rupees of present value, and the project clears its cost with room to spare.

Check it against the NPV. 369,017.77 minus 300,000 is 69,017.77. Now run the identity: 1 plus 69,017.77 over 300,000 is 1.2301. The same number, as it must be.

That present value figure, incidentally, came from our PVIFA calculator. Five payments of 90,000 at 7 percent, using an annuity factor of 4.1001974359. Which is the honest way to use this tool: work out the present value properly somewhere else, then bring it here.

The one situation where it beats NPV

If you can fund every worthwhile project, net present value is the better guide and the profitability index adds nothing. Take everything with a positive NPV, in any order, and you have maximised value.

Almost nobody is in that position. Budgets are fixed, and the real question is which subset of projects to fund. That constraint has a name, capital rationing, and it is where this ratio earns its place.

Three projects, a budget of 600,000:

Rank on NPV alone and X wins outright. It creates 150,000 of value, more than Y or Z on their own, and it uses the entire budget.

Rank on the index and Y comes first at 1.32, then Z at 1.30, then X at 1.25. Y and Z together cost exactly 600,000 and create 186,000 of value.

Thirty six thousand better than the choice NPV pointed at, from the same budget.

The reason is that NPV measures the size of the prize and ignores what the prize cost to win. When capital is the binding constraint, what you want is the most value per unit of capital, which is precisely what the index measures. Rank by index, work down the list, stop when the money runs out.

Two caveats on that procedure, both real. It assumes projects are independent, so funding one does not affect another. And it assumes they are indivisible in the sense that you take them whole, which means the ranking can leave an awkward remainder of budget that fits nothing. In practice you check the top few combinations by total NPV rather than trusting the ranking blindly.

The input this calculator does not compute

Worth being straightforward about where the work actually is.

The division here is trivial. The number that decides everything is the present value of the future cash flows, and you have to arrive with it already worked out.

Getting it involves three things, in rough order of difficulty.

Forecasting the cash flows. The genuinely hard part, and no formula helps. Use cash flows rather than accounting profit, since depreciation is not a payment and working capital tied up is.

Choosing the discount rate. Usually the cost of capital, which our WACC calculator works out when funding is a mix of debt and equity. This choice moves the answer a great deal, so it is worth running the index at a rate either side of your estimate.

Discounting them. Mechanical once the first two are settled. For a level stream, our PVIFA calculator. For payments that grow at a steady rate, the growing annuity calculator. For uneven flows, the discounted cash flow calculator. For a single future amount, the present value calculator.

Two conventions to settle before you type anything. Decide whether the initial investment is a single outlay at time zero, which is what this ratio assumes, or spread across several periods, in which case those outlays should be discounted too. And keep the treatment of tax and inflation consistent between the cash flows and the discount rate, since mixing a real rate with nominal cash flows is one of the most common ways a capital budgeting number goes wrong.

Questions people ask

What index is good enough?

Anything above 1 creates value. How far above depends on what else you could fund with the same money, which is why the ranking matters more than the level when budgets are tight.

Should I use this or NPV?

NPV when you can fund everything worthwhile, since it measures the total value created. The index when capital is limited and you have to choose between projects.

Can they disagree?

Never about a single project, since an index above 1 and a positive NPV are the same condition. They can rank a set of competing projects differently, and when the budget binds the index ranking is the one to follow.

What does an index below 1 mean?

That the discounted value of what comes back is less than what goes in, so the project destroys value. That is the same statement as a negative NPV.

How do I work out the PV of future cash flows?

Forecast the cash flows, choose a discount rate, and discount each one. Use the PVIFA calculator for a level stream, the growing annuity calculator for a rising one, and the discounted cash flow calculator for uneven flows.

Some of my future cash flows are negative.

Include them at their present value in the numerator, so the figure entered is the net present value of everything after time zero. A large negative flow late in a project can pull the index below 1 even when the early years look good.

Is this the same as a benefit cost ratio?

Very close. Benefit cost ratios in public sector appraisal are built the same way, discounted benefits over discounted costs, with the same rule that anything above 1 is worth doing.

References

A note on the sources. The profitability index is an investment appraisal rule rather than a reported figure, so the authorities here are the discounting mechanics it rests on rather than a regulator defining the ratio itself. The compounding relationship that makes a present value meaningful is defined by the Securities and Exchange Commission's investor education office, and their free calculator can check any discounting step from the other direction. The treatment of the index as the correct ranking rule under capital rationing, and of net present value as the correct rule when capital is unconstrained, follows the standard corporate finance text.

1. Brealey, R.A., Myers, S.C., and Allen, F., Principles of Corporate Finance, McGraw-Hill Education, chapters on net present value, the profitability index and capital rationing.
2. U.S. Securities and Exchange Commission, Office of Investor Education and Advocacy, Compound Interest, Investor.gov glossary, on the compounding relationship that discounting reverses. https://www.investor.gov/introduction-investing/investing-basics/glossary/compound-interest
3. U.S. Securities and Exchange Commission, Compound Interest Calculator, Investor.gov, useful for verifying a present value by compounding it forward. https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator
4. CFA Institute, Residual Income Valuation, on assessing whether an investment earns a return above the opportunity cost of the capital committed to it. https://www.cfainstitute.org/insights/professional-learning/refresher-readings/2026/residual-income-valuation