Expected Net Cash Flows

Year Franchise L Franchise S

0 ($120) ($120)

1 20 90 2 70 15

3 85 60

Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows. You also have made subjective risk assessments of each franchise, and concluded that both franchises have risk characteristics that require a return of 14%. You must now determine whether one or both of the franchises should be accepted.

9. Look at your NPV profile graph without referring to the actual NPVs and IRRs. Which franchise or franchises should be accepted if they are independent? Mutually exclusive? Explain. Are your answers correct at any cost of capital less than 12%?

10. What is the underlying cause of ranking conflicts between NPV and IRR?

11. What does the profitability index (PI) measure? What are the PIs for Franchises S and L?

12. What is the payback period? Find the paybacks for Franchises L and S. What is the rationale for the payback method? According to the payback criterion, which franchise or franchises should be accepted if the firms maximum acceptable payback is 2 years, and if Franchises L and S are independent? If they are mutually exclusive?