xpanding very rapidly in recent years, making its shareholders rich in the process. The average annual rate of return on the stock in the past few years has been 22%, and HFGC managers believe that 22% is a reasonable figure for the firm's cost of capital. To sustain a high growth rate, HFGC's 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 products into a new market. Cash flows from each project appear in the following table: Year Plant expansion Product Introduction 0 −$3,300,000 −$400,000 1 $2,500,000 $300,000 2 $2,750,000 $275,000 3 $2,250,000 $350,000 4 $1,500,000 $300,000 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 undertake only one investment. What do you think the firm should do?
xpanding very rapidly in recent years, making its shareholders rich in the process. The average annual rate of return on the stock in the past few years has been 22%, and HFGC managers believe that 22% is a reasonable figure for the firm's cost of capital. To sustain a high growth rate, HFGC's 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 products into a new market. Cash flows from each project appear in the following table: Year Plant expansion Product Introduction 0 −$3,300,000 −$400,000 1 $2,500,000 $300,000 2 $2,750,000 $275,000 3 $2,250,000 $350,000 4 $1,500,000 $300,000 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 undertake only one investment. What do you think the firm should do?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question
The High-Flying Growth Company (HFGC) has been expanding very rapidly in recent years, making its shareholders rich in the process. The average annual
|
Year
|
|
Plant expansion
|
Product Introduction | |
|
0
|
|
−$3,300,000
|
−$400,000
|
|
|
1
|
|
$2,500,000
|
$300,000
|
|
|
2
|
|
$2,750,000
|
$275,000
|
|
|
3
|
|
$2,250,000
|
$350,000
|
|
|
4
|
|
$1,500,000
|
$300,000
|
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 undertake only one investment. What do you think the firm should do?
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