A large retail company wants to determine which investment project it should invest in. Since you are the vice president of the company, you have been asked to analyze these two projects and report back to the board of directors regarding which of these two projects the company should undertake. Project A has an initial investment cost of $42,000. This project is expected to produce $9,450 in net cash flows each year for 7 years. Project B has an initial investment cost of $36,750 with an expected net cash flow of $7,875 per year for 5 years. Both investments have a 10% cost of capital.
- What is each project’s NPV?
- What is each project’s IRR?
- What is the payback period for each project?
- Which investment project do you recommend for your company? Be sure to explain why you arrived at the decision that you did.
—PLEASE USE THE RESOURCES —
***** Key Point of Lesson 1
- Net present value (NPV) is considered the ideal capital budget decision-making tool managers can use for making an investment decision on a project because it takes into consideration the time value of money and the maximizing of intrinsic value. This lesson also covers how to calculate NPV.*****
***** Key Point of Lesson 2
- The IRR is yet another common tool used by managers to assess an investment. The IRR is basically the rate of return that makes the NPV of all cash flows from a project equal zero. This lesson defines and explains IRR and how to calculate it.*****
Key Point of Lesson 3
- One of the simplest investment decision-making tools used by management to determine whether or not to invest in an investment project is the payback period. It allows you to use the time period needed to recover the cost of a project when making a capital budgeting decision. This module explains the payback period and how to calculate it.