What does the Profitability Index measure?

The Profitability Index (PI) specifically measures the relative profitability of a project by comparing the present value of future cash flows generated by that project to the initial investment required. By calculating the PI, an organization can evaluate how much value is created for each dollar invested. A PI greater than 1 indicates that the project is expected to generate more value than its cost, suggesting that it is a good investment opportunity. This index is particularly useful in capital budgeting decisions, allowing decision-makers to rank projects and allocate resources effectively based on their potential profitability.

Understanding this metric is crucial for assessing potential investments, distinguishing it from concepts like future investment growth, liquidity of assets, or risk assessment, which do not directly focus on profitability comparisons in the same way.