Answer
A project is selected only when the profitability index is
greater than 1 and the IRR is greater than the required rate of
return.
Project profitability index is computed by dividing the net
present value of the project by initial investment and the adding 1
to the quotient.
Project profitability index can be greater than 1 only if the
net present value of the project is positive. And if the net
present value of the project is positive that would cetainly mean
that the IRR of the project is greate than the required rate of
return.
Thus, it can be concluded that, when project profitability index
and IRR are being used to rank a project, they will always result
in the same preference ranking for investment projects.
The second option from above is the correct
answer.
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Answer: Option c is right.
Profitability index = Present value of inflow /
Investment.
Internal rate of return is the actual return on our
invested capital.
While calculating the profitability index we use the
discounted factor given in the question and calculate the present
value of the inflows. But in internal rate of return we actually
try to find out the rate of return given by the inflows. Both have
their different criteria to measure wheather investment is worthy
or not.
Therefore it result in different ranking for investment
projects.
