The finance manager of Willow plc is evaluating two mutually exclusive projects with the following cash flows.

Question:

Willow's cost of capital is 10 per cent and both investment projects have zero scrap value. The company's current return on capital employed is 12 per cent (average investment basis) and the company uses straight-line depreciation over the life of projects.
(a) Advise Willow which project should be undertaken if:
(i) The net present value method of investment appraisal is used;
(ii) The internal rate of return method of investment appraisal is used;
(iii) The return on capital employed method of investment appraisal is used.
(b) Discuss the problems that arise for the net present value method of investment appraisal when capital is limited, and explain how such problems may be resolved in practice.

Net Present Value
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