Suppose a firm is considering two mutually exclusive projects, A and B; both have required rates of return of 10 percent. Project A involves a $200 initial outlay and a cash inflow of $300 at the end of year 1, whereas project B involves an initial outlay of $1,500 and a cash inflow of $1,900 at the end of year 1. The net present values, profitability indexes, and internal rates of return for these projects are given in Table 10-8.

In this case, if the NPV criterion is used, project B should be accepted; whereas if the PI or IRR criterion is used, project A should be chosen. The question now becomes, which project is better?

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TABLE 10-8 The Size-Disparity Ranking Problem PROJECT A YEARS Cash Flow NPV = $72.73 PI = 1.36 IRR = 50% PROJECT B YEARS Cash Flow NPV = $227.28 PI = 1.15 IRR = 27% 0 -200 0 -1,500 k = 10% k = 10% 1 300 1 1,900