1.31 Project Scale
Below we see two mutually exclusive projects, one of which requires greater investment and thus also, as it were, produces annual higher FCFs, – and NPV. The other has a smaller investment, but higher FCFs relative to the outlay – and a higher IRR. Put differently, the outlay for “A” is 50% higher than for “B,” the smaller project. However, the FCFs for “A” are only about 43% greater than for “B.”
We will use 10% as the discount rate for the NPV calculation. Note the conflict between the two indicated rules of thumb as below.
| Year | FCF Project A | FCF Project B |
| 0 | ($3,000) | ($2,000) |
| 1 | 1,000 | 700 |
| 2 | 1,000 | 700 |
| 3 | 1,000 | 700 |
| 4 | 1,000 | 700 |
| 5 | 1,000 | 700 |
| NPV | $790.80 | $653.55 |
| IRR | 19.86% | 22.11% |
| PI | 1.26 | 1.32 |
IRR and PI say accept “B,” while NPV says accept “A.”
The IRR is a measure of return, while the NPV provides a measure of the expected dollar increase in wealth. The NPV is largely affected by scale. The IRR and PI will yield consistent results with one another; these methods are more affected by inflows relative to outflows.
What should the company do?