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Consider the following cash flows on two
mutually exclusive projects that require an annual return of 15 percent. Working the financial planning department for
the Bahamas Recreation Corp., you are trying to compare different investment
criteria to arrive at a sensible choice of these two projects.
Deapwater New Submarine
Year Fishing Ride
0 -$600,000 -$1,800,000
1 270,000 1,000,000
2 350,000 700,000
3 300,000 900,000
a.
(10 points) Based on the
payback period rule, which project should be chosen?
b.
(10 points) If your decision
rule is to accept the project with a greater IRR, which project should you
choose?
c.
(10 points) To be prudent, you
compute the NPV for both projects.
Which project should you choose?
d.
(10 points) Roughly draw the
NPV profiles of the two projects. (1)
What is the crossover rate? (2) Is the
NPV’s choice consistent with the IRR rule?
If not, explain why.
