The calculation of the return on investment is associated with an objective assessment of future income and production costs. The profitability index shows how many times an investor can increase his capital by adding it to the company's fixed capital.
Instructions
Step 1
The return on investment index is important not only for potential investors, but also for the enterprise itself. Whether the company will receive additional capital depends on how effectively it conducts its economic activities in the field of cost optimization, pricing, marketing research and, as a result, making a profit. And therefore, will it be able to develop and expand its production.
Step 2
The analysis of profitability shows the degree of attractiveness of a particular enterprise for investing the investor's own funds. In particular, the profitability index allows you to determine what the expected income after the sale of the goods will bring investments for each invested monetary unit (ruble, dollar, etc.)
Step 3
The profitability index is equal to the ratio of the present value of the invested project to the investment costs for its implementation: PI = ∑ CF_k / (1 + i) ^ k / INV, where: CF_k - cash flow of the enterprise in time period k; i - discount rate; INV - volume investment funds.
Step 4
The present value of the project is the net present value, which is equal to the difference between the present value of the projected project and the volume of the initial investment. This indicator itself is significant for shareholders, because it reflects the direct increase in the company's capital. It only makes sense to talk about ROI if it has a positive value.
Step 5
The discount rate is usually taken equal to the refinancing rate. Also, its value can be equal to the average rate of return in the market, adjusted for possible risk (problems with implementation, inflation, etc.) Discounting is the calculation of the projected present value of a project using the compound interest formula.
Step 6
It should be noted that a negative value of the present value of the project does not necessarily mean that the project is unattractive for investment, but only the wrong choice of the discount rate. It is enough to change this value and the calculation may give a different result. This suggests that it is necessary to carefully analyze future investments in order not to miss out on the maximum possible profit.
Step 7
The profitability index is the rate of return expressed as a percentage: PI = P / 100% + 1, where P is the return on investment, a positive value.
