NPV (Net Present Value) versus PI (Profitability Index)
Consider the following two mutually exclusive projects available to Global Investments, Inc.:
|
Projects |
C0 |
C1 |
C2 |
PI |
NPV |
|
A |
-$1000 |
$1000 |
$500 |
1.32 |
$322 |
|
B |
-500 |
500 |
400 |
1.57 |
285 |
The appropriate discount rate for the projects is 10%. Global Investments chose to undertake project A. At a luncheon for shareholders, the manager of a pension fund that owns a substantial amount of the firm’s stock asks you why the firm chose project A instead of project B when project B has a higher PI.
How would you, the CFO, justify your firm’s action? Are there any circumstances under which Global Investments should choose project B?
