You are offered two mutually exclusive projects, A and B. Project A requires you to invest $50,000 today and will pay of $6,000 every year forever, with the first payment due next year. Project B requires initial investment of $150,000, and will pay off $15,000 every year, starting next year.
(a) Compute the payback period for the two projects. Which project would you choose based on the payback period rule?
(b) What are the IRRs of the two projects? (Hint: start with the definition of IRR, then use a formula to compute the present value of future cash flows.)
(c) Based on the IRRs you computed above (and nothing more), which project would you choose? What would you ignore if you made your choice based on the IRR only?
(d) Suppose you determined that the appropriate discount rate for these projects is 8%. Which project should you choose? You do not need to use IRR to answer this question.