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Calculation of Integrated Conflicting Rankings

Question

The 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 20%, and HFGC managers believe that 20% 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.

a. Calculate the NPV, IRR, and PI for both projects.
b. Rank the projects based on their NPVs, IRRs, and PIs.
c. Do the rankings in part bagree or not? If not, why not?
d. The firm can only afford to undertake one of these investments, and the CEO favors the product introduction because it offers a higher rate of return (that is, ahigher 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

Summary

The question is about Integrative- Conflicting Rankings. A company named High-Flying Growth Company is evaluating two project options for investment. It wants to invest in the highest return offering project. For this purpose, the projects’ NPV, IRR, PI are calculated.

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Comments

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