Decision Rules
Decision Rules
| Technique | Accepting Criteria for Single or Independent Project(s) | Accepting Criteria for Mutually Exclusive Projects |
|---|---|---|
| DPB | Less than the Target Period | Shortest Payback Period |
| ARR | Above the Target Rate | With the highest ARR |
| NPV | A positive NPV | With the highest positive NPV |
| IRR | Higher than the Target Rate (Cost of Capital) | With the highest IRR |
In this table:
- DPB stands for Discounted Payback Period, but if you're referring to the traditional method, it should be just "Payback Period" (PB).
- ARR is Accounting Rate of Return.
- NPV is Net Present Value.
- IRR is Internal Rate of Return.
For Single or Independent Projects:
- Payback Period (PB): The project is acceptable if its payback period is less than the target period set by the company.
- ARR: A project is considered good if its ARR is above the company’s target rate.
- NPV: Projects with a positive NPV should be accepted as they are expected to add value to the company.
- IRR: If a project’s IRR exceeds the target rate or the company’s cost of capital, it is acceptable.
For Mutually Exclusive Projects (where you must choose one among several projects):
- Payback Period: The project with the shortest payback period is preferred.
- ARR: The project with the highest ARR is preferred.
- NPV: Among competing projects, the one with the highest positive NPV is chosen because it is expected to add the most value.
- IRR: The project with the highest IRR is preferred, provided the IRR is above the cost of capital.
This decision matrix allows companies to evaluate investment opportunities in a structured way to determine the best use of capital for maximized returns.
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