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Definition: Profitability index is a financial tool which tells us whether an investment should be accepted or rejected. It uses the time value concept of money and is calculated by the following formula.
The accept-reject decision is made as follows:
If PI is greater than 1, accept the investment. If PI is less than 1, reject the investment and if PI = 1, then indifferent (may accept or reject the decision)
Description: Profitability index helps in ranking investments and deciding the best investment that should be made. PI greater than one indicates that present value of future cash inflows from the investment is more than the initial investment, thereby indicating that it will earn profits.
PI of less than one indicates loss from the investment. PI equal to one means that there are no profits. Thus, profitability index helps investors in making decisions about whether or not to make a particular investment.
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