One of the efficiency metrics of Financial Investment defined as:
| (1) | \mbox{PI} = 1 + \frac{\mbox{NPV}}{\mbox{I}_0} = \frac{\mbox{PV}[CF^+]}{I_0} |
where
\mbox{NPV} | Net Present Value |
\mbox{I}_0 | Initial Investment |
CF^+ = \{ CF^+_0, \ CF^+_1, \ CF^+_2, \ ... \} | Cash Inflows |
The key difference with NPV is that PI shows a value of returns per unit cash invested.
This particularly means that some Projects with higher NPV may be less attractive in PI terms than Projects with lesser NPV as they require a higher Initial Investment.
This allows a fair comparison of investment efficiency between two investment projects with different Initial Investment volumes.
The corporate investment policy usually dictates that:
- investment Projects with PI ≤ 1 should be rejected
- investment Projects with higher PI should have a priority over the Projects with lower PI
- investment Projects with lower PI are added up to the Investment Package to reach the pre-set value of affordable Initial Investment (I0)
- investment Projects with lower risk should have a priority over the Projects with higher risk
The quantification of Project's is performed individually for each Project based on its nature.
Weighing the Project's risks against PI to include to or exclude from Investment Package is based on the Corporate Investment Policy.
The formula
(1) assumes that the only cash outflow would be the initial investment
I_0.
If this is not the case and the future cash flows include additional investments (for example additional paid in capital and/or CAPEX) then one need to give a preference to other methods of assessing the investment profitability, like Present Value Index (PVI) and Modified Internal Rate of Return (MIRR).
See also
Economics / Investment / Financial Investment
[ Net Present Value (NPV) ][ Present Value Index (PVI) ]