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Question 1 (10 marks) Pegasus Limited has been growing very rapidly in recent years, making its shareholders rich in the process. The average annual rate

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Question 1 (10 marks) Pegasus Limited has been growing very rapidly in recent years, making its shareholders rich in the process. The average annual rate of return on the stock in the last few years has been 16%, and BDC managers believe that 16% is a reasonable figure for the firm's cost of capital. To sustain a high growth rate, Pegasus CEO argues that the company must continue to invest in projects that offer the highest rate of return possible. Two projects are currently under review. The first is an expansion of the firm's production capacity, and the second project involves introducing one of the firm's existing products into a new market. Cash flows from each project appear in the following table. a. Calculate the NPV and IRR for both projects. (4 marks) b. Rank the projects based on their NPVs and IRRs. (2 marks) c. Do the rankings in part b agree or not? If not, why not? (2 marks) d. 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 (that is, a higher IRR) than the plant expansion. What do you think the firm should do? Why? ( 2 marks)

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