Fuji Software Inc. has two mutually exclusive projects A and B. Their cash flows are given in the following table.
Year Project A Project B
0 -$7,500 -$5,000
1 $4,000 $2,500
2 $3,500 $1,200
3 $1,500 $5,200
(a) Compute the payback period of the two projects. Suppose Fuji's cutoff payback period is two years. Which of these two projects should be chosen using the payback period rule?
(b) Suppose Fuji uses the NPV rule to rank these two projects. If the appropriate discount rate is 15 percent, which project should be chosen?
(c) Discuss why the payback period rule and the NPV rule can give different ranking.
(d) Verify that project B has an internal rate of return of 30%.
(e) Discuss two problems of using internal rate of return for capital budgeting.