Project A has an NPV of $20,000 and a PI of 1.2. Project B has an NPV of $10,000 and a PI of 1.3. Both projects have equal lives. Which project should be preferred if we are NOT concerned with capital rationing
(that is, we are NOT concerned with being short of funds)?
A) We should prefer Project B since it has a higher PI.
B) We should compute the EAA before we make any decision.
C) We should prefer Project A since it has a higher NPV.
D) We should prefer Project B if it has a higher IRR.
Answer: C
Explanation: C) We should NOT prefer Project B even though it has a higher PI; this is because it has a lower NPV and we are not facing capital constraints. Computing the EAA is typically used if we have mutually exclusive projects with unequal lives; we do not know if such is the case for this situation since we are not told if the projects are mutually exclusive (we are only asked which one we would prefer, i.e., which one adds more value to the company). Even if Project B has a higher IRR, this would not tell us to prefer it because it has a lower NPV.
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