How to Explain Profitability Index
The profitability index is calculated for an investment based upon an initial investment and the future cash flows that are going to be received from that investment. Compare an investment against the present net value of all future cash flows with help from the co-founder of a business advisory company in this free video on profitability index.
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The profitability index is calculated for an investment based on your initial investment, and then all of the future cash flows that you are going to receive from that investment. So you would take your initial investment, and then you would compare that against the net present value of all the future cash flows you are going to have off the investment. You would take the net present value of those cash flows, and divide that by your initial investment, which gives you what they call a profitability index. Typically that index would be above or below one, and if it is above one it is a profitable investment. If it is below one then it is a losing investment. You would be losing money. If you calculate your profitability index again you take your net present value of all the money or all the income you are going to receive, and divide that by your initial investment. If that comes out to a profitability index of say one point six that is telling you that you are going to receive one dollar sixty for every dollar you invest. By the same token if it gives you something less than one it would be losing money. You'd receive at a point seven you would receive seventy cents for every dollar you invested.