Question
Consider the following cash flows on two mutually exclusive projects that require an annual return of 15 percent. You are the investment manager of Coxs
Consider the following cash flows on two mutually exclusive projects that require an annual return of 15 percent. You are the investment manager of Cox’s Beach Resort Ltd. and required to make an investment choice between the projects using different capital budgeting criteria.
Year Deepwater Fishing New Submarine Ride
0 ($600,000) ($1,800,000)
1 270,000 1,000,000
2 350,000 700,000
3 300,000 900,000
Required:
(a) Based on the discounted payback period rule, which project should you choose? Explain limitations of the discounted payback period rule in the capital budgeting choice.
(b) If your decision rule is to accept the project with a greater internal rate of return (IRR), which project will you recommend for investment? Should the required rate of return be 20 percent instead of 15 percent, does your investment choice remain unchanged? If no, why?
(c) IRR rule has scale problem and can be misleading sometimes. Calculate the incremental IRR for the cash flows. Which project should you choose?
(d) Calculate net project value (NPV) for both the projects. Which project should you choose and is it consistent with the incremental IRR rule?
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