Consider the cash flows for the following three projects: A, B, and C.
Project A CO -5000 C1 +1000 C2 +1000 C3 +3000 C4 0
Project B CO -1000 C1 0 C2 +1000 C3 +2000 C4 +3000
Project C CO -5000 C1 +1000 C2 +1000 C3 +3000 C4 +5000
If the opportunity cost of capital is 11%, and you have unlimited access to the capital, which one(s) would you accept? Why did you answer the way you did? Would your response change if the cost of capital is 16%? Why or why not?
Suppose that you have limited access to the capital and you need to choose only one project. Which one would you choose and why? The discount rate is still 11%.
What is the payback period of each project? Please analyze if, in general, a decision based on payback is consistent with a decision based on NPV.
What are the internal rates of return (IRR) on the three projects? Does the IRR rule in this case give the same decision as NPV? How do you know?
If the opportunity cost of capital is 11%, what is the profitability index for each project? Please analyze if, in general, decisions based on profitability index are consistent with decisions based on NPV.
What is the most generally accepted measure to choose between the projects? Please justify your answer.
Sample Solution
