The profitability index, or PI, the method compares the present value of future cash inflows with the initial investment on a relative basis. Therefore, the PI is the ratio of the present value of cash flows (PVCF) to the initial investment of the project.

In this method, a project with a PI greater than 1 is accepted, but a project is rejected when its PI is less than 1. Note that the PI method is closely related to the NPV approach. In fact, if the net present value of a project is positive, the PI will be greater than 1. On the other hand, if the net present value is negative, the project will have a PI of less than 1. The same conclusion is reached, therefore, whether the net present value or the PI is used. In other words, if the present value of cash flows exceeds the initial investment, there is a positive net present value and a PI greater than 1, indicating that the project is acceptable.

PI is also known as a benefit/cash ratio.

Project L

Accept the project if PI > 1.

Reject if PI < 1.0