When faced with size disparity, which project selection criterion is most effective?

The most effective project selection criterion when faced with size disparity is the choice based on the highest net present value (NPV). NPV is a financial metric that calculates the present value of all cash flows (both incoming and outgoing) associated with a project, discounted at the company’s cost of capital.

This method is paramount because it provides a comprehensive assessment of the expected profitability of a project in absolute dollar terms. When comparing projects of different sizes, NPV accounts for the time value of money and allows for an accurate appraisal of the expected financial return over the project's lifespan.

In scenarios where projects differ in scale, relying solely on other criteria, such as internal rate of return (IRR) or profitability index (PI), may lead to misleading conclusions. The IRR can be skewed for projects of different sizes because it does not take into account the actual money involved, while the profitability index can also misrepresent the value if cash flows are particularly large or small. Furthermore, prioritizing shorter lifespans does not inherently correlate with financial effectiveness; it's more about the total value generated.

By focusing on NPV, decision-makers ensure that they are selecting the project that maximizes shareholder wealth, ultimately leading to better long-term financial strategy and investment