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NPV Vs PI Discussion

Net Present Value (NPV) and Profitability Index (PI) are key financial metrics used to evaluate investment projects, with NPV measuring the difference between present value cash inflows and outflows, while PI assesses attractiveness by comparing future cash inflows to initial investment. NPV is favored for its comprehensive consideration of the time value of money, though both metrics have advantages and limitations, such as reliance on accurate cash flow estimates. Ultimately, NPV is often regarded as the primary criterion for investment decisions, with PI serving as a supplementary tool for comparing projects of varying scales.

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35 views8 pages

NPV Vs PI Discussion

Net Present Value (NPV) and Profitability Index (PI) are key financial metrics used to evaluate investment projects, with NPV measuring the difference between present value cash inflows and outflows, while PI assesses attractiveness by comparing future cash inflows to initial investment. NPV is favored for its comprehensive consideration of the time value of money, though both metrics have advantages and limitations, such as reliance on accurate cash flow estimates. Ultimately, NPV is often regarded as the primary criterion for investment decisions, with PI serving as a supplementary tool for comparing projects of varying scales.

Uploaded by

Arpan Bhattacharya
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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NPV vs PI

Introduction to NPV
vs PI
Net Present Value (NPV) and Profitability Index (PI) are widely used financial evaluation metrics for
investment projects. They provide valuable insights into the potential return of an investment and aid in
decision-making.

Definition and calculation of NPV :


Definition : Calculation :
NPV is the difference between the It is calculated by subtracting the
present value of cash inflows and the initial investment from the present
present value of cash outflows over a value of expected future cash flows.
period of time. It helps in assessing
the profitability of an investment by
taking into account the time value of
money.
Advantages and limitations of NPV :
1 Advantages :
• NPV considers the time value of money
and provides a clear metric for evaluating
investment decisions.
• Considers the time value of money.
• Provides a clear indication of the 3 Limitations :
profitability of an investment. It may be challenging to estimate
future cash flows accurately, leading
2 Disadvantages : to potential deviations in the actual
NPV.
• Assumes a specific discount rate, which
may be subject to uncertainty.
• Requires accurate estimation of cash
flows.
Definition and calculation of PI :
Definition :
PI is a ratio that measures the
attractiveness of an investment by
dividing the present value of future
cash inflows by the initial investment
cost.

Calculation :
It is calculated by dividing the present
value of future cash flows by the initial
investment.
Advantages and limitations of PI :
1 Advantages :
• Simplicity in calculation and interpretation.
• Helps in comparing projects with different
scales of investment.

3 Limitations :
It does not account for the scale and
size of investments, which may lead
to potential biases.
2 Disadvantages :
• Like NPV, it depends on the accuracy of
cash flow estimates.
• It doesn't consider the scale of the
project, which may lead to incorrect
decisions when comparing projects with
different sizes.
Comparison of NPV and PI :
Criteria Net Present Value (NPV) Profitability Index (PI)

Consideration of Time Yes Partial


Value of Money

Comparison of Project Scale No Yes

Clarity in Ranking Projects High Medium


Conclusion :
Both NPV and PI play vital roles in investment decisions, and their application depends on the specific
characteristics of the projects being evaluated. NPV is often considered the more comprehensive and
widely accepted criterion for evaluating investment projects. It directly accounts for the time value of
money and provides a clear indication of the project's impact on shareholder wealth.
In summary, while both NPV and PI are valuable tools in capital budgeting, NPV is often considered the
primary criterion due to its comprehensive consideration of the time value of money and direct impact
on shareholder wealth. PI can be used as a supplementary measure, especially when comparing
projects of different scales.
Reference :
• Engineering Economics Analysis ; Donald G Newnan
• https://www.tutorialspoint.com/difference-between-net-present-value-npv-and-profitability-index-pi

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