Question

Under what circumstances will the net benefit-cost ratio give you a different recommendation about the choice of projects as compared to the recommendation you get using the net present value criterion?

Answer 1

In general Practice, NPV and benefit cost ratio provides the same results but in the situation of capital rationing when there is limitation of available funds, and investment opportunities are more, then the best possible projects with capital limit are selected. So in case of Capital rationing and specially in case of indivisible projects, benefit cost ratio and NPV give contradictory results, because project with highest NPV would be left out if available funds are less than the required fund for project. So in case of capital rationing and indivisible project NPV and benefit cost ratio will offer inconsistent results. In this situation, profitability index gives results inconsistent with the maximization of shareholder wealth and it should not be used. Indeed, the concept of capital rationing gives results inconsistent with the maximization of shareholder wealth. It is hard to believe that a firm with positive NPV projects can not go out.