Understanding Scale Differences in Mutually Exclusive Investment Proposals

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When two mutually exclusive investment proposals have scale differences, it means that the cost of the projects differs. In this scenario, ranking the projects on the basis of IRR, NPV, and PI methods may give contradictory results. The question asks whether this will always, never, or generally be the case.

The answer is that it may give contradictory results. This is because different investment appraisal techniques use different criteria to evaluate projects, and these criteria may not always be aligned.

IRR (Internal Rate of Return) is the rate at which the net present value of the project becomes zero. It is calculated based on the expected cash inflows and outflows of the project. IRR ranks projects based on the highest return on investment.

NPV (Net Present Value) is the difference between the present value of the project's cash inflows and the present value of its cash outflows. NPV ranks projects based on the highest net value that can be gained from the project.

PI (Profitability Index) is the ratio of the present value of the project's cash inflows to the initial investment. PI ranks projects based on the highest ratio of present value of cash inflows to the initial investment.

When comparing two mutually exclusive projects, if one has a higher initial cost but generates more cash inflows in the future, it may have a higher NPV and PI. However, if the other project has a lower initial cost and generates a higher IRR, it may be ranked higher based on IRR.

Therefore, in situations where two mutually exclusive investment proposals have scale differences, ranking them based on different investment appraisal techniques may give contradictory results. This is because each technique has its own strengths and weaknesses, and the choice of which method to use depends on the project's specific characteristics and goals.