Question

If NPV, IRR and/or PI methods return conflicting results (one rule suggests project A is better the other rule suggests project B is better) your decision primarly will be based on which rule?

Answer 1

Profitability index suffers from many limitations such as that it is difficult to estimate the required rate of return ands that it values short term gains better than long term gains.

The NPV and IRR approaches use different reinvestment rate assumptions so there can be a conflict in project acceptance when mutually exclusive projects are considered.

The NPV methods reinvests cash flow at the WACC and IRR methods reinvests cash flow at the IRR.

Reinvestment at WACC is the superior assumption, so when mutually exclusive projects are evaluated the NPV approach should be used for the capital budgeting decision.

Hence, the NPV method is the better rule.

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