Chapter 10, Problem 10.27P

Integrative: Conflicting Rankings The High-Flying Growth Company (HFGC) has been expanding 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 20%, and HFGC managers believe that 20% 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 involves introducing one of the firm's existing products into a new market. Cash flows from each project appear in the following table.

1. a. Calculate the NPV, IRR, and PI for both projects.
2. b. Rank the projects based on their NPVs, IRRs, and Pls.
3. c. Do the rankings in part b agree or not? If not, why not?
4. d. The firm can afford to undertake only one of these investments, and the CEO favors the product introduction because it offers a higher rate of return (i.e., a higher IRR) than the plant expansion. What do you think the firm should do? Why?

Year	Plant expansion	Product introduction
0	–$3,500,000	–$500,000
1	1,500,000	250,000
2	2,000,000	350,000
3	2,500,000	375,000
4	2,750,000	425,000