NPV is superior to IRR for mutually exclusive investments. Finally, NPV and IRR make different assumptions when it comes to reinvestment assumptions. This can result in conflicts and crossover in ranking of mutually exclusive projects.
Profitability Index (PI)
The PI calculates the present value of a project compared to its cost. It is the sum of the present values of the project divided by the initial cost of the investment.
(Algorithm: PI = NPV / Investment)
Profitability Index Decision Rule
When faced with mutually exclusive investments with capital rationing (i.e. A limit on the amount of funds available for investment), choose the project with the highest PI. (FIN 301)
PI is only used in connection with capital rationing.
Payback Period
This is the number of years that it takes for the total cash net flows of a project to accumulate to the cost of the initial cash outlay. or, in the other words, the length of time that it takes to recover the initial cost of the investment.
(Algorithm: Cost of Project
Annual Cash Inflows)
For budgetary reasons,...
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