A key metric in capital budgeting, it represents the ratio of the current worth of future money flows anticipated from an funding to the preliminary funding quantity. The outcome provides a simple indication of the worth created per unit of funding. For instance, if the current worth of future money flows is $1,200,000 and the preliminary funding is $1,000,000, the index is 1.2, implying that for each greenback invested, $1.20 of current worth is generated.
This index aids in prioritizing potential investments, notably when capital is constrained. Tasks with an index better than 1 are typically thought of acceptable as a result of they’re anticipated to generate worth for the group. Traditionally, such a evaluation has grown from less complicated strategies of assessing funding returns and contributes in the direction of efficient strategic decision-making. Its use permits an entity to match tasks of various scales and funding ranges on a normalized foundation.