Both planning and implementation of the investment project are fraught with a number of difficulties. Obviously, first you need to solve all the problems that arise at the planning stage. Any business is not only an idea, but also a large number of calculations. The person who is planning the investment project has to determine both technical and economic indicators. Among the latter, a special place is occupied by those that form a system of indicators of economic efficiency.
Strictly speaking, in this system you can include any indicators that, in your opinion, most accurately characterize the effectiveness of the project in question. However, there are indicators that are always calculated; without them, it is impossible to submit a single business plan. This category includes the net present value (denoted by NPV), internal rate of return (denoted by IRR), the return on investment period (denoted by PP), and the profitability index of the investment project (denoted by IP or PI). Each of these indicators is important in its own way, but it is in the system that they allow the most holistic assessment of the project and the conclusion about the feasibility of investments.
Let us dwell in more detail on such an indicator as the profitability index. In principle, its calculation and economic sense are identical to any other indicator of profitability. Each of these relative values shows the economic efficiency of the use of resources. For example, return on assets shows the level of profit that each unit of asset value brings.
In our case, the profitability index characterizes how many rubles of profit each ruble invested in investing brings. Based on this definition, we can conclude on how to calculate this indicator. It is clear that it is necessary to attribute the amount of profit to the amount of capital investment. But such a simple calculation will be extremely inaccurate, and it can be used only for the most approximate assessment "by eye". To do everything correctly and accurately, it is necessary to take into account the influence of the time factor. To do this, the economic mechanism uses a discount mechanism that allows you to bring the future value to the current point in time. Thus, we get that in the fraction numerator is the amount of discounted profit for the entire project implementation period, and in the denominator is the sum of the reduced investments.
Naturally, the profitability index has a certain value, which is borderline, separating effective projects from ineffective ones. As you can already understand, this value is one. This level means that investments are fully covered by profit. If it is supposed to receive from the project any effect other than economic, then it can be considered effective, otherwise it is better to find a more profitable investment method.
The level of profitability is directly related to the indicator of the net cost of the project, reduced to the present moment (NPV). If you have already calculated the NPV value, then profitability can be determined as follows: it is necessary to divide NPV by the value of the discounted investment, and then add one to the result. Obviously, a negative value of NPV will lead to the fact that profitability will be less than unity, and therefore, the project is inefficient. Zero net cost of the project will be associated with profitability at the unit level, which means that in the presence of other positive effects, the project can already be accepted.
It should be remembered that the project profitability index cannot single-handedly describe the effectiveness of the proposed investment, therefore, for an objective and accurate assessment, it is desirable to calculate the entire system of indicators.