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What is capital budgeting? What is the payback period and how is it calculated? What is the accounting rate of return (ARR)? What is the difference between capital and revenue expenditure in budgeting? Why is the initial investment treated as a time-zero cash outflow? What are the advantages and disadvantages of the payback method? What is a hurdle rate? What is the difference between mutually exclusive and independent projects? What is the difference between a screening and a preference decision? What is the time value of money and why does it matter in capital budgeting?
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What is the profitability index (PI)?

Beginner

Answer

The profitability index is the ratio of the present value of a project's future cash inflows to the initial investment (or NPV per unit invested). A PI above 1 indicates a positive NPV. It's especially useful for ranking projects under capital rationing to get the most value per dollar of scarce capital.
PI = PV of inflows / Initial investment. PI > 1 -> accept.
Real-world example A project with PI of 1.3 returns $1.30 of present value per $1 invested.

Common follow-ups: What PI indicates acceptance? | When is PI most useful?

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All 34 Capital Budgeting questions