Growth Enterprises, Inc. (GEI) has $40 million that it can invest in any or all of the four capital investment projects, which have cash flows as shown in Table 1 below.

Table 1 ComparisonofProjectCashFlows* ($thousands)

Year of Cash Flow

Type of Project Cash Flow

A. Investment Revenue

Operating expenses

Year 0

($10,000)

Year 1

$21,000 11,000

Year 2

$17,000 7,833

$11,000 4,889

$10,000 5,555

Year 3

($10,000) Operating expenses 5,833

C. Investment ($10,000) Revenue $10,000

Operating expenses 5,555

D. Investment ($10,000) Revenue $30,000

Operating expenses 15,555 *All revenues and operating expenses can be considered cash items.

B. Investment Revenue $15,000

$30,000 15,555

$5,000 2,222

Each of these projects is considered to be of equivalent risk. The investment will be depreciated to zero on a straight-line basis for tax purposes. GEIs marginal corporate tax rate on taxable income is 40%. None of the projects will have any salvage value at the end of their respective lives. For purposes of analysis, it should be assumed that all cash flows occur at the end of the year in question.

Rank GEIs four projects according to the following four commonly used capital budgeting criteria:

1) Payback period.

2) Accounting return on investment. For purposes of this exercise, the accounting return on investment should be defined as follows: Average annual after-tax profits / (Required investment)/2

3) Internal rate of return.

4) Net present value, assuming alternately a 10% discount rate and a 35% discount rate.

Why do the rankings differ? What does each technique measure and what assumptions does it make?

If the projects are independent of each other, which should be accepted? If they are mutually exclusive (i.e., one and only one can be accepted), which one is best?