Question

x Step 30 of 30 Final decision: In this case, according to NPV criterion, Project A should be selected but according to payback period, discounted payback period, IRR, and profitability index criterion, Project B should be selected. But, the final outcome should be based on NPV because compared to other capital budgeting techniques, NPV does not have ranking problem. Hence, finally Project A should be accepted.

Hi,

I have a question regarding #17, (f).
On the solution, it says "NPV doesn't have ranking problem." What does it mean by that?

Thank you very much in advance!

Answer 1

NPV of each project is calculated separately.

Net present value also has its own decision rules, which include the following:

• Independent projects: If NPV is greater than $0, accept the project.
• Mutually exclusive projects: If the NPV of one project is greater than the NPV of the other project, accept the project with the higher NPV. If both projects have a negative NPV, reject both projects.

The IRR formula result is on an annualized basis, which makes it easier to compare different projects. The NPV formula, on the other hand, gives a result that considers all years of the project together, whether one, three, or more, making it difficult to compare to other projects with different time frames.

The IRR may give conflicting decisions where the timing of cash flows varies between the 2 projects, Whereas NPV will give absolute result, it will rank a project adding more dollar value, higher regardless of the initial investment required

The NPV method considers the net present value figure but does not take into account the amount of investment required for the project. Therefore, this method is not appropriate for comparing or ranking competing projects that require different amounts of investment.