Profitability Index - Benefit Cost Ratio (Hindi) - YouTube

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Intro

Namaskar, my name is Mukul & you are welcome to Asset Yogi

Where we unlock the knowledge of finance rather than locking it

In this video, we will talk about Profitability Index

This is also called the Benefit-cost ratio

It is a project evaluation technique

Let's say if you want to invest in a project, Then should you invest in that project or not

So profitability index is a technique for finding that

Net present value & IRR are also such techniques

I request you to watch my NPV & IRR videos, before watching this video

So that you can clearly understand this concept

In this video, we will understand the concept of profitability index in detail

If you have to evaluate a single project

whether you should invest in it or not, then how can you do it

Then multiple projects, if you are evaluating which will be the best project to invest in,

Then we will use Profitability Index and NPV. How to use this combination,

After that, we will also see inside Microsoft Excel, how we can do the calculation easily,

So you must stay in this video from beginning to last,

So that, the concept will be clear to you very well

Let's move straight toward the blackboard

Let us first look at the formula of profitability index,

Then your profitability index is your present value of cash inflows divided by the present value of cash outflows

Cash inflow means whatever the net cash flow coming to you every year

Let's say If the project is of 5 years,

Then cash inflow as much came in 5 years, every year

Its present value net present value, we are talking about only cash inflow

Right,

Divided by present value outflows,

Means initial investment,

If you had made as much initial investment,

Then it becomes its ratio, the profitability index,

If we want to say it in the ratio of benefit & cost,

Then it becomes your present value of benefits divided by the present value of cost

The meaning of both is the same

Even here you have to find out the present value of the same cash inflows

And here the cost is your initial investment,

So now we understand this from the example,

Suppose there is a car rating company

Which is evaluating, operations on a new route.

Then what will be my profitability?

And from that, he wants to find out whether he should drive that car or not

Now let's say on which new route he wants to drive, let's say its cost is ₹ 10 L

Of a car Whom he wants to run on that route,

Then if we see the cashflows of it,

Let's say, its cash flows look like this

See it is outflows, I have written it at the bottom,

Then it is an investment of ₹ 10L, So I put it on a zero timeline

It means in today's date if you put this 10L

And Let's say this vehicle would have earned one and a half lakh rupees in the first year,

Then the net cash flows, inflows are one and a half lakh rupees in the first year,

okay, in the second year, it earns two lakh rupees,

In the third year, it earns three lakh rupees.

In the fourth year, the car becomes a little old, let's say, the competition increases a bit, on that route, it earns 2.50L,

In fifth year, maybe the company will sell this vehicle

Let's say terminal cash flows, suppose after five years car sells in 4 lakhs

And they earned 2 lakh from the operations

The cashflow of operation will be 2 lakhs

Terminal cash flow means you sold the project or car

So those will be cashflows

So If 4 lakh cash flows come here then total cash flows for the fifth year is 6 lakh

What we have to do now,

We have to find the present value of all cash flows, of all five.

Directly what we can do is, we find out the net present value of these five cashflows

Okay, so I have already taken it out,

So the present value of inflows,

which will be, that will become out to you 11 lakh 78 thousand 280 rupees

So this is 11 lakh 78 thousand 280 I have extracted this from Microsoft excel I will show you how to get the

Rest I have made my video net present value

You must watch that video

In it, It has been explained in great detail

That how do we calculate the present value and net present value

And if we take out its NPV

NPV is your net present value in which your investment also counted

The net present value is in that case will be 1 lakh 78 thousand 280 in it, right

then we can also find out from NPV whether we should invest or not,

As I also told in my video of NPV that

If your NPV also become positive, it means whatever effort you are taking,

Right, then if your money is lying in the bank, you are not at any risk

Then if you are taking any effort and taking any risk

Then your NPV should be positive if it is positive,

So you can accept that project and invest in it,

You can check my NPV video

Watch it before watching this video, So that you can easily understand

Now lest get to the profitability index

Here I have talked about the present value of Inflows

We will go through it that how is it calculated, but for now, we should understand the profitability index

Then you will calculate the present value of outflows

This is not required because you have already invested 10 lakh in 0 date

So here the present values of outflows are 10 lakh

So now for calculating the profitability index, the present value of inflows is 11,78,280

Divided by 10 lakh

so that we can get profitability index

The value is 1.18

So now what do we have learned from PI,

Is that if you are investing 1 rupee in returns you will can 1.18 rupees from this project

That means from every rupee you are earning 18 paise

This means there are 18% returns from this project

So the PI shows the returns and the earnings on every rupee

so basically If PI is more than one case you can accept the project and if it is less than the one you can reject it,

In case of less than one means your present value of inflows are less than outflows

This means you can not be able to get that much-invested money that you had invested

That is why if Pi is more than 1 then only you should accept the project,

Secondly, the NPV shows the value added by the project in the company

As we have seen its NPV is 1,78,280 rupees

This means the efforts of the 10 lakhs and the risk by the company

from that, the value addition is 1,78,000

The PI showing that how much money you earn per rupees of the investment

Let's understand it with one more example

Recently we had talked about only one project

That if you want to analyze only one project then how you will analyze it whether to invest it in or not

Now lest see if you have a limited budget and have to choose from one in three projects

Let's say if your budget is 10 lakh in the company

You have 2-3 options whether to drive the vehicle of 10lakh or the bigger one

Or the small one, there can be a different combination such as 5lakh, 4lakh, or 10lakh

So let's take the example of projects A, B, and C

May be possible they have different NPV,

Let's say the NPV of project A is1,78,200 rupees

For the second project, the NPV is 1,50,000

And for the third project, the NPV is 1lakh rupees

If you go according to NPVs in that project a is the best because it is giving maximum NPV of up to 1,78,280

Or adding the maximum value in the company

But this is the half information as we did not know how much investment we have made the net present value,

Let's say if we have more information we will analyze it according to that

Let's say the inflow is 11,78,280 and the investment is up to 10 lakh

In the second case here the 1,5lakh of earning on the investment of 5 lakh

In the third case, the earning of 5 lakh is on the investment of 4lakhs

In such cases, PI helps in comparing the projects so we will calculate the Pi of all the cashflows

We have recently calculated the PI of the previous project is 1.18

In the second case when you divide 4.5 lakh from 5 lakh you will get 1.3

And in project C when you divide 5 lakh from 4lakh we will get 1.25

As you can see project B is giving handsome returns, on every rupee you are learning 30 paise,

So in the first case, you are earning18 paise on every rupee, and in their case, it is 25 paise on every rupee

So here the project b will be the best project you can select project B in this case,

Now the second question arises that when the budget was of 10 lakh

Then if you had selected this project the rest 5 lakh rupees are at the bank

you are not earning some extra returns on that

You want that I should get good returns on my 10 lakhs

In that case, you can do is that if the vehicle cost 5 lakhs you can purchase 2 of them to run them on the route,

If this is possible

If we take 2 cars of 5 lakhs then NPV will be doubled

If we take 2 cars in project B, then the Net Present Value will be 3 lakhs

This 3 lakhs NPV is much more if we compare it to Project A NPV, i.e. 1,78,280

So if we do the overall analysis, then we will calculate NPV, IRR

IRR shows annual returns of every year

We can also see Profitability Index & Payback Period, I have already made videos on the Payback period

I have already made videos on all these, These are the different techniques to evaluate projects

If we use their combination in a project, then we can get the outcome of that project

And then you can also compare the projects

So the goal of every company, business, or individual should be maximization NPV

That how much money can be added from those projects

Or how much value can be added to the company, That should be our goal

So I think, you have to understand the concept of the Profitability Index

Now we see how to calculate the Profitability Index in Excel

I have plotted all the cash flows in Microsoft Excel

Our cash inflows are starting from Year 1

Year 1 = 150,000, Year 2 = 200,000, Year 3 = 300,000 Year 4 = 250,000, Year 5 = 600,000

If we sell the car then we will get the amount of 400,000

Operation cash flow = 200,000 Total = 600,000 in Year 5

To calculate the present value of inflows, We will type =NPV

We will type =NPV(

Then type the values required, Here, the rate is the discount rate

As I have explained to you in detail in the NPV video

Here we will take that discount rate, which we can earn risk-free

Let's say, you can earn risk-free money in FD with an interest of 7%

So here we will type =NPV(0.07

We can earn this risk-free, It is an opportunity cost of capital

Let's say if you have had invested this money in any other project, how much interest you might get there

That money should be earned without any effort & risk

So we will take the 7% rate of FD, as it is risk-free

If you think you can earn 10% risk-free from any other project, then you can take 10%

The discount rate may be different for each company, It may depend on individual

Then we will type "," & then give space " " & then select all these values

Those values whose NPVs are to be found

Now we will close the bracket ")"

So we will get the Present Value of cash inflows

PV (Inflows) of 5 Years = 1,178,280

PV(Outflows) = 1,000,000, this is our initial investment at Year 0

To find PI we have to divide those both & we will get the answer, Here, PI = 1.18

So you can calculate PI like this

If you want to understand PV, NPV & Discount Rate, then watch our detailed videos on NPV & IRR

If there was any point missing or you want to add something, Then share them in the comment section

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