Question

Which of the following statements are correct about the decision rules for net present value (NPV) and Profitability Index (PT) A) They always result in the same decision O B) They may result in different decisions C) NPV is always greater than PH D) a and E) b and

Answer 1

NPV = present value of future cash flows - initial cash outflow

PI = present value of future cash flows / initial cash outflow

PI is ratio , on the other hand NPV is difference

lets understand both with an example :

Let's say

Project A :

initial cash outflow = 10,000

Present value of future cash flows = 20,000

here NPV = 20,000 - 10,000 = 10,000

PI = 20,000 / 10,000 = 2

Project - B:

initial cash outflow = 100,000

present value of future cash flows = 150,000

NPV = 150,000 - 100,000 = 50,000

PI = 150,000 / 100,000 = 1.5

if we compare both the projects

NPV of Project B is higher than NPV of project A on the other hand PI of Project A is higher

so they may result in different decissions

in case of decission making NPV method is Superior  to PI. so NPV is always greater than PI

so , Option E is correct