The conference on evaluating capital projects has been very helpful. You have received a significant amount of information and multiple projects to evaluate to hone your skills. To adequately teach Grammy and the board you will need to answer several questions about the capital-budgeting process. You will do this in a business memo that is no more than four pages long.
Provide an evaluation of two proposed project, both with a 5-year expected lives and identical initial outlays of $110,000. Both of these projects involve additions to a highly successful product line, and as a result, the required rate of return on both projects has been established at 12 percent. The expected free cash flows from each project are as follows:
Project A Project B
Initial outlay -$110,000 -$110,000
Inflow year 1 20,000 40,000
Inflow year 2 30,000 40,000
Inflow year 3 40,000 40,000
Inflow year 4 50,000 40,000
Inflow year 5 70,000 40,000
k. How does a change in the required rate of return affect the project’s internal rate of return?
l. What reinvestment rate assumptions are implicitly made by the NPV and IRR methods? Which one is better?