GSOE9830 Chap.9 Comparing Projects and Decision Indicators
Comparing Projects and Decision Indicators
Project indicators answer different questions. NPV measures dollar value added at the required return, IRR expresses a percentage embedded in the cash-flow pattern, payback measures recovery speed, and capital productivity relates value to scarce investment. Scale and timing can make the measures rank mutually exclusive projects differently.
This chapter uses NPV profiles and incremental value to explain the conflict and treats delay as a value cost when positive receipts move later. Comparable alternatives must share a viewpoint, study boundary, service basis and justified rate before their indicators are ranked. A crossover in NPV profiles explains why the preferred project can change as opportunity cost changes.
Simple payback omits time value and all later cash flows, while discounted payback still omits post-recovery value. Supporting indicators can describe liquidity or constrained capital, but they should not silently replace the criterion chosen for value maximisation.
What this chapter covers
- 01
Project scale
- 02
Cash-flow timing
- 03
Crossover rate
- 04
Incremental NPV
- 05
Payback
- 06
Capital productivity
Worked example · free
Choose between projects with different scale and timing
- +1Project A NPV is $3,305.79.
- +1Project B NPV is $14,184.82.
- +1Incremental value from choosing B is $10,879.04.
- +1Choose B when only one can be built and value is the criterion.
Key terms
- Crossover rate
- The discount rate where two projects have equal NPV.
- Payback period
- The time required for cumulative cash flow to recover the initial outlay.
- Capital productivity
- A value measure scaled by the capital committed.
- Incremental NPV
- The NPV of one alternative less the NPV of another.
Comparing Projects and Decision Indicators FAQ
Why can NPV and IRR rank projects differently?
A smaller project can return cash sooner and produce a higher percentage, while a larger or later project creates more total value. Scale and timing produce the conflict.
When is payback useful?
Payback highlights how quickly capital is recovered and can support a liquidity screen. It omits later value and usually should not replace NPV as the main value criterion.
How does delay affect a project?
At a positive discount rate, delaying positive receipts lowers present value. Quantify the NPV loss and compare it with any cost saving or strategic benefit created by waiting.
Exam move
Put alternatives on a common viewpoint, study boundary and discount-rate basis before calculating indicators. Confirm that each option delivers comparable service and that mutually exclusive means only one complete project can be selected. If lives differ, apply the repeatability or annual-equivalent treatment supplied by the problem.
An indicator comparison is meaningless when the underlying alternatives are not economically comparable. Calculate NPV first as the governing value measure. Expand the dated terms and retain the common rate beside every result. Then compute IRR, simple or discounted payback and any capital-productivity measure requested.
Label what each number answers: total value added, embedded percentage return, recovery time or value relative to scarce capital. Do not merge these meanings into a single good-project score. When rankings conflict, inspect scale and timing. A smaller early-return project can have a higher IRR and faster payback while a larger project creates more dollar value. Draw or sample both NPV profiles and locate any crossover.
At the stated required return, choose the higher NPV for a mutually exclusive value-maximising decision. Use the other measures to explain liquidity, timing or capital constraints. Calculate incremental cash flow from the smaller or lower-cost option to the larger one when appropriate. Its NPV shows whether the extra investment creates value at the required rate.
Its sign pattern may explain an incremental IRR or reveal ambiguity. Keep incremental value in currency units and avoid subtracting percentages as though they were dollars. Practise payback with uneven cash flows. Accumulate receipts until the remaining unrecovered balance falls within a year, then divide that balance by the next year’s receipt under the stated within-year assumption.
Write the limitations beside the answer: simple payback ignores time value before recovery and all flows after recovery. Discounted payback corrects the first issue but still ignores later value. Test delay explicitly. Move the same positive stream one year later while leaving the initial outlay fixed, recalculate NPV and explain why value falls at a positive rate.
This exercise makes timing conflict visible and prevents delay from being described as neutral because undiscounted totals match. Maintain an error log for inconsistent lives, different rates, IRR used as dollar value, payback treated as NPV, post-payback cash ignored without warning and capital-rationing ratio used when no constraint exists.
Before submission, state the governing criterion, preferred project, incremental value and reason a supporting indicator differs. A strong answer resolves the decision and preserves the information carried by the conflict.