You have joined the Projects division of GrowMore Inc. Your first job is to analyze two projects, which you have code-named “alpha” and “beta.” Both projects will require the same initial investment of $100,000 and are expected to generate the following cash flows over an expected economic life of 4 years.
Assuming that GrowMore Inc.’s cost of capital for these projects is 10%:
a. Calculate its (1) payback period and (2) discounted payback period. Which project would you select under these methods? Explain your answer.
b. Calculate net present values for each project and indicate which one you would undertake using this decision rule.
c. Calculate internal rates of return for each project. Which project would you select using the IRR rule?
d. Calculate the profitability index for each project and indicate your decision using this rule.
e. Can you think of any situations in which, because of a change in the cost of capital, you might be confronted with conflicting decisions using the NPV and IRR rules? Show how this might happen.