Problem:
Suppose you are a new capital-budgeting analyst for a company considering investments in the eight projects listed in Exhibit. The chief financial officer of your company has asked you to rank the projects and recommend the "four best" that the company should accept.
In this assignment, only the quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive. All the projects require the same initial investment, $2 million. Moreover, all are believed to be of the same risk class. The weighted average cost of capital of the firm has never been estimated. In the past, analysts have simply assumed that 10 percent was an appropriate discount rate (although certain officers of the company have recently asserted that the discount rate should be much higher).
| Sum of Cash Flow Benefits |
$ 3,310 |
$ 2,165 |
$ 10,000 |
$ 3,561 |
$ 4,200 |
$ 2,200 |
$ 2,560 |
$ 4,150 |
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| Excess of Cash Flow over initial investment |
$ 1,310 |
$ 165 |
$ 8,000 |
$ 1,561 |
$ 2,200 |
$ 200 |
$ 560 |
$ 2,150 |
1. Can you rank the projects simply by inspecting the cash flows?
2. What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why?
3. What is the ranking you found by using quantitative methods? Does this ranking differ from the ranking obtained by simple inspection of the cash flows?
4. What kinds of real investment projects have cash flows similar to those in Exhibit?