Profitability Index Ranking

Rank three projects by profitability index under capital rationing.

Problem Scenario

Budget is $500K. Project X: cost $200K, PV $260K. Project Y: cost $300K, PV $420K. Project Z: cost $250K, PV $300K.

Given Data

Budget$500,000

X cost / PV$200K / $260K

Y cost / PV$300K / $420K

Z cost / PV$250K / $300K

Requirements

Calculate PI for each
Select optimal combination within budget

Solution

Step 1:

PI_X = 260/200 = 1.30.

Step 2:

PI_Y = 420/300 = 1.40.

Step 3:

PI_Z = 300/250 = 1.20.

Step 4:

Rank: Y (1.40) > X (1.30) > Z (1.20). Select Y + X = $500K exactly.

Final Answer

Choose Y (PI=1.40) and X (PI=1.30). Total cost = $500K, total NPV = $180K.

Key Takeaways

✓PI is best for ranking under capital constraints
✓Higher PI means more value per dollar

Common Errors to Avoid

✗Using NPV to rank when capital is limited (PI is better)
✗Forgetting budget constraint

Practice More Problems with AI

Snap a photo of any problem and get instant explanations.

Download FinanceIQ

FAQs

Common questions about this problem type

Use integer programming or evaluate all feasible combinations within the budget.

Not when projects differ in size. PI gives value per dollar, so it favors smaller, efficient projects. NPV measures total value created. Under capital rationing, PI ranking maximizes total NPV within the budget constraint.