Distinguish between NPV and PI. Which of these is considered better?

Question

20 Feb 2025

Answer :

Word Count : 681

Net Present Value (NPV) and Profitability Index (PI) are both financial metrics used in capital budgeting to evaluate investment projects, but they differ in their approach and interpretation.

Net Present Value (NPV):
NPV is the sum of the present values of all cash inflows and outflows associated with a project over its lifetime. It represents the absolute value that an investment is expected to add or subtract from a company’s wealth. The NPV formula is given by:

\[
NPV = \sum \frac{C_t}{(1 + r)^t}
\]

where \(C_t\) is the cash flow in time period \(t\), and \(r\) is the discount rate (cost of capital).

A positive NPV indicates that the project is expected to add value to the company and should be accepted, while a negative NPV suggests that the project will destroy ___ ______ __________ ______ __________ ___ _______ ____.
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