1) A Company has been rising very speedily in current years, making it shareholders rich in process. The average annual rate of return on stock in last few years has been 20% and last few years have been 20%, and its managers believe that 20% is the reasonable figure for firms cost of capital. To maintain a high growth rate, the CEO argues that company should continue to invest in projects which offer the highest possible rate of return. 2 projects are presently under review. First is the expansion of firms production capacity, and 2nd project involves introducing one of the firms existing products into the new market. Cash flows from each project appear in the table given below.
i) Compute the NPV, IRR, and PI
ii) Rank the projects based on NPV IRR and PI.
iii) Do the rankings in part B agree or not? If not, why not?
iv) The firm can only afford to undertake one of these investments, and the CEO favours the product introduction because it offers a higher rate of return (i.e., a higher IRR) than plant expansion. What do you think the firm must do? Describe why?
Year Plant Expansion Plant Introduction
0 -3,500,000 -500,000
1 1,500,000 250,000
2 2,000,000 350,000
3 2,500,000 375,000
4 2,750,000 425,000