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Chapter: Specific Investment Decisions
Topic: Capital rationing
Activity 3
They calculated the PI as: (NPV + Initial investment)/Initial investment
However in the lecture it was calculated as: NPV/Initial investment
Can you clarify what should be used please or whether it makes a difference?
Thanks much.I would say NPV/ Outlay (Investment)
As per the examiner
But I will say the profitability index (PI) can be calculated in two ways: either as NPV divided by the initial investment (NPV/Initial investment) or as (NPV + Initial investment) divided by the initial investment. While the resulting numbers may differ, the decisions made based on these calculations will generally remain the same. Therefore, both methods can be valid, but the standard approach is to use NPV/Initial investment.
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