Question

Match drawbacks to the following capital budgeting techniques

IRR (Ignore Scale, Provide conflicting answers w/ NPV for independent projects, Favor projects with early positive cash flow, or bias against short-term projects)

PI (Ignore Scale, Provide conflicting answers w/ NPV for independent projects, Favor projects with early positive cash flow, or bias against short-term projects)

Payback Period   (Ignore Scale, Provide conflicting answers w/ NPV for independent projects, Favor projects with early positive cash flow, or bias against short-term projects)

Answer 1

NPV: Ignore Scale

NPV Decisionrule is If NPV > 0 Accept the project. Ignoring scale of the project this decision was taken

IRR: Provide conflicting answers w/ NPV for independent projects

For two independent projects sometime IRR value is higher than required rate of cost of capital in NPV calculation. But what makes IRR not viable that ig IRR is higher percentage like more than 20% reinvestment of cash flows at same rate quite impossible every time. While reinvestment in cost of capital which eemains very low comperative to IRR canbe done easily. Thus IRR may roduce conflicting answers w/ NPV for independent projects.

PI: Bias against short-term projects

PI -Profitability Index provide ratio of future cash generated to current Investment. So for long term projects future cash genration will be quite high as compare to short term project. Hence PI Bias against short-term projects

Payback Period: Favor projects with early positive cash flow

Payback period is how early company gets back its initial investment. Thus it prefer only project with early positive cash flow.