This is because the investment’s profit margin isn’t as high as the initial investment. With that said, you can expect to come up with a lower result when calculating a project size with a larger cash outflow. When calculating the project’s profitability index using the profitability index formula, it’s worth noting that the calculation doesn’t consider the size of the investment. If the potential earnings are lesser than the amount you invested initially, it won’t make sense to invest in that particular project. This is the cash used at the start of the project. The initial investment is simply the sum of money required to fund the project. N = expected number of years before seeing an ROI I = anticipated interest rates in letting the amount of money sit idly Here is the formula for calculating the present value (PV):

This works on the time value of money accounting principle, which states that money you have available at present day is worth more than what that same amount will be in the future, due to its potential earning capacity.

The present value is the discounted value of the expected cash flow as a result of the investment in the future. The future cash flow is the amount of money that the company expects to earn in the future for that specific investment. Profitability Index = Present Value (PV) of Future Cash Flow from Projects / Initial Investment Required A method used in discounted cash flow for ranking a range of projects under consideration in which standard cash flow patterns are projected.

Here is the formula for calculating a project’s profitability index: The higher a product or project’s profitability index is, the better investment it is for the company. A profitability index of 1.0 is the breakeven point, so anything less than that would indicate a loss of profit for a company. Ideally, a business project should have a profitability index greater than 1.0 to be considered a profitable investment.

Profitability index