IThe? High-Flying Growth Company? (HFGC) has been growing very rapidly in recent? years, making its shareholders rich in the process.
The average annual rate of return on the stock in the last few years has been 23?%, and HFGC managers believe that 23?% is a reasonable figure for the? firm's cost of capital.
To sustain a high growth? rate, the HFGC CEO argues that the company must continue to invest in projects that offer the highest rate of return possible.
Two projects are currently under review. The first is an expansion of the? firm's production? capacity, and the second project involves introducing one of the? firm's existing products into a new market. Cash flows from each project appear in the following? table:
|
Year
|
|
Plant expansion
|
Product introduction
|
|
|
0
|
|
-?$4,600,000
|
|
-?$500,000
|
|
|
1
|
|
?$3,000,000
|
|
?$350,000
|
|
|
2
|
|
?$3,000,000
|
|
?$375,000
|
|
|
3
|
|
?$2,750,000
|
|
?$325,000
|
|
|
4
|
|
?$2,000,000
|
|
?$275,000
|
|
a. Calculate the NPV for both projects. Rank the projects based on their NPVs.
b. Calculate the IRR for both projects. Rank the projects based on their IRRs.
c. Calculate the PI for both projects. Rank the projects based on their PIs.
d. The firm can only afford to undertake one of these investments. What do you think the firm should? do?