PROFITABILITY INDEX (PI)
Profitability Index is also called as Benefit Cost Ratio or Present Value Index. It is calculated by dividing the Present value of cash flows by present value of cash outflows.
MERITS OF PROFITABILITY INDEX METHOD
- It considers the time value of money.
- All cash inflows are considered.
- It helps in achieving the basic objectives of maximizing shareholders wealth.
DEMERITS OF PROFITABILITY INDEX METHOD
- It fails in resolving capital rationing when projects are indivisible.
- Situations may arise where a project with low P.I in combination with another project may give the least result than a project with high Profitability Index (PI).
ACCEPT AND REJECT CRITERIA FOR PROFITABILITY INDEX
- If P.I >0, Accept the project,
- If P.I <0, Reject the project and
- If P.I=0, may or may not accept the project.