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Technical note: Equivalence of different profitability criteria with the net present value

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  • Pasqual, Joan
  • Padilla, Emilio
  • Jadotte, Evans

Abstract

Net present value has long been regarded in academic circles as the best criterion for project appraisal; however, several alternative, complementary methods remain popular with practitioners. This paper demonstrates that, if properly applied, several of these standard criteria – such as net final value, internal rate of return, benefit–cost ratio, profitability index, equivalent annuity, discounted payback period and average payback period – lead to the same investment decision as net present value. Moreover, the paper proves that when choosing between two mutually exclusive projects, the application of these criteria to the difference project provides the same ranking as net present value. Therefore, although net present value is regarded as a superior investment criterion, any of these popular criteria, properly applied, serve as well.

Suggested Citation

  • Pasqual, Joan & Padilla, Emilio & Jadotte, Evans, 2013. "Technical note: Equivalence of different profitability criteria with the net present value," International Journal of Production Economics, Elsevier, vol. 142(1), pages 205-210.
    • Handle: RePEc:eee:proeco:v:142:y:2013:i:1:p:205-210
    DOI: 10.1016/j.ijpe.2012.11.007
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    References listed on IDEAS

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    1. Joan Pasqual Rocabert & José Antonio Tarrío & María José Pérez, 2005. "Anomalies in net present value calculations. A solution," Hacienda Pública Española / Review of Public Economics, IEF, vol. 173(2), pages 47-60, June.
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    5. Osborne, Michael J., 2010. "A resolution to the NPV-IRR debate?," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(2), pages 234-239, May.
    6. De Reyck, Bert & Degraeve, Zeger & Vandenborre, Roger, 2008. "Project options valuation with net present value and decision tree analysis," European Journal of Operational Research, Elsevier, vol. 184(1), pages 341-355, January.
    7. Carlo Alberto Magni, 2010. "Average internal rate of return and investment decisions: A new perspective," PROYECCIONES FINANCIERAS Y VALORACION 006653, MASTER CONSULTORES.
    8. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
    9. Carlo Magni, 2011. "Addendum to “Average Internal Rate of Return and Investment Decisions: A New Perspective”," The Engineering Economist, Taylor & Francis Journals, vol. 56(2), pages 181-182.
    10. Pasqual, Joan & Tarrío, José Antonio & Pérez, María José, 2001. "Falsas anomalías de la función valor actual neto," DEE - Documentos de Trabajo. Economía de la Empresa. DB db010503, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    11. Gordon Hazen, 2009. "An Extension of the Internal Rate of Return to Stochastic Cash Flows," Management Science, INFORMS, vol. 55(6), pages 1030-1034, June.
    12. Brounen, D. & de Jong, A. & Koedijk, C.G., 2004. "Corporate Finance In Europe Confronting Theory With Practice," ERIM Report Series Research in Management ERS-2004-002-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
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    Cited by:

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    2. Petković, Dalibor & Shamshirband, Shahaboddin & Kamsin, Amirrudin & Lee, Malrey & Anicic, Obrad & Nikolić, Vlastimir, 2016. "Survey of the most influential parameters on the wind farm net present value (NPV) by adaptive neuro-fuzzy approach," Renewable and Sustainable Energy Reviews, Elsevier, vol. 57(C), pages 1270-1278.
    3. Magni, Carlo Alberto & Marchioni, Andrea, 2020. "Average rates of return, working capital, and NPV-consistency in project appraisal: A sensitivity analysis approach," International Journal of Production Economics, Elsevier, vol. 229(C).
    4. Cuthbert, James R. & Magni, Carlo Alberto, 2016. "Measuring the inadequacy of IRR in PFI schemes using profitability index and AIRR," International Journal of Production Economics, Elsevier, vol. 179(C), pages 130-140.
    5. Marchioni, Andrea & Magni, Carlo Alberto, 2018. "Investment decisions and sensitivity analysis: NPV-consistency of rates of return," European Journal of Operational Research, Elsevier, vol. 268(1), pages 361-372.
    6. Carapellucci, Roberto & Giordano, Lorena & Pierguidi, Fabio, 2015. "Techno-economic evaluation of small-hydro power plants: Modelling and characterisation of the Abruzzo region in Italy," Renewable Energy, Elsevier, vol. 75(C), pages 395-406.
    7. Carlo Alberto Magni, 2015. "ROI and profitability index: A note on managerial performance," Department of Economics 0048, University of Modena and Reggio E., Faculty of Economics "Marco Biagi".
    8. Baidoo, Edwin & Natarajan, Ramachandran, 2021. "Profit-based credit models with lender’s attitude towards risk and loss," Journal of Behavioral and Experimental Finance, Elsevier, vol. 32(C).

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