Given the following to select the most profitable projects from several Independent projects: 1) Greatest total NPV 2) Largest sum on Profitability indexes 3) HIghest IRRs 4) Greatest Present Value of total expected incremental Cash flows. Which one would you leave out?
First you need to define what “most profitable projects” mean… nevertheless, with unlimited budget, you should select all the NPV positive projects. If you are asking for a subset of the projects yielding the greatest profitability, then start by sorting the projects from highest to lowest NPV. Start with the highest NPV and start adding projects. Include all projects but stop before the first negative project. There you have the largest subset of projects yielding the greatest profitability. So, I guess that means (1) is ok, (2) is ok, and (4) is ok, but not (3). Leave out (3), if I understood the problem correctly.
> If you are asking for a subset of the projects > yielding the greatest profitability, then start by > sorting the projects from highest to lowest NPV. > Start with the highest NPV and start adding > projects. Include all projects but stop before > the first negative project. There you have the > largest subset of projects yielding the greatest > profitability. You don’t need this method for this problem… you could just take all positive NPVs. But you would use this method if you were told to select “n” projects (say any 5 project subset) with the highest profitability.
THanks Dreary! Question was asking to select the best 5 out of n projects (independent). And you were right to leave out the IRRs when making the decision. I was also wondering what you reasoning is to leave out option 3) HIghest IRRS? Is it because high IRRs can still be less than cost of capital and me may not catch this using this method?
SOmetimes, NPV and IRR can be conflicting with each other when Cost of capital is less than cross over rate. Does someone know why?