Question:

Southern Oregon Business (SOB) a business firm operating in the Rouge Valley is currently looking to invest in Project A with the estimated cash flows as follows:

Initial Investment at start of project = $3,600,000

Cash Flow at end of year 1 = $500,000

Cash Flow at end of years 2 through 6 = $625,000 each year

Cash Flow at end of years 7 through 9 = $530,000 each year

Cash Flow at end of year 10 = $385,000

SOB financial manager would like to evaluate Project A through various capital budgeting models so as to ensure that this project is worthy of investment.

Please answer the following questions:

1. SOB wants to know payback period of this project. Suppose the cutoff period is 6 years. Based on the decision rule for payback period, determine whether SOB should accept or reject this project. Show your work and provide reasons for your answer.

2. Suppose the appropriate discount rate is 14%, and SOB wants to know the net present value (NPV) of this project. Based on the NPV decision rule, determine whether SOB should accept or reject this project. Show your work and provide reasons for your answer.

3. Suppose the appropriate hurdle rate is 14%, and SOB wants to know the internal rate of return (IRR) for this project. Based on the IRR decision rule, determine whether SOB should accept or reject this project. Show your work and provide reasons for your answer.

4. From your answers in questions 1-3, did you find the payback period, NPV and IRR yield the same result regarding whether or not it is worth to invest in Project A? If there is any inconsistency, which method would you recommend the financial manager at SOB to follow? Provide reasons for your answer, and discuss some of the strengths and shortcomings of your recommended method.

5. Suppose there is an alternative investment, namely project B, whose NPV is $80,350. Assume that Project A and B are mutually exclusive (i.e., the companies must choose a single project due to its limited resources for investing in multiple projects at the same time). Would you recommend SOB to invest in Project A or Project B? Provide reasons for your answer.