JK Products, Inc. is considering investing in either of two competing projects that will allow the firm to eliminate a production bottleneck and meet the growing demand for its products. The firm's engineering department narrowed the alternatives down to two-Status Quo (SQ) and High Tech (HT).
Working with the accounting and finance personnel, the firm's CFO developed the following estimates of the cash flows for SQ and HT over the relevant six-year time horizon. The firm has an 11 percent required return and views these projects as equally risky.
|
Initial Outflow(CFo)
Year (t)
|
Project SQ
$670,000
|
Project HT
$940,000
|
| Cash Inflows (CFi) |
|
1
|
$250,000
|
$170,000
|
|
2
|
200,000
|
180,000
|
|
3
|
170,000
|
200,000
|
|
4
|
150,000
|
250,000
|
|
5
|
130,000
|
300,000
|
|
6
|
130,000
|
550,000
|
a. Calculate the net present value (NPV) of each project, assess its acceptability, and indicate which project is best, using NPV.
b. Calculate the internal rate of return (IRR) of each project, assess its acceptability, and indicate which project is best, using IRR.
c. Calculate the profitability index (PI) of each project, assess its acceptability, and indicate which project is best, using PI.
d. Draw the NPV profile for project SQ and HT on the same set of axes, and use this diagram to explain why the NPV and the IRR show different preferences for these two mutually exclusive projects. Discuss this difference in terms of both the "scale problem" and the "timing problem."
e. Which of the two mutually exclusive projects would you recommend that JK Products undertake? Why?