ST15.2 Decision Rule Conflict. Kate O’Brien has been retained as a management consultant by…

ST15.2 Decision Rule Conflict. Kate O’Brien has been retained as a management consultant by Winfred-Louder, a local department store, to analyze two proposed capital investments, projects X and Y. Project X is a sophisticated working capital and inventory control system based upon a powerful personal computer, called a system server, and PC software specifically designed for inventory processing and control in the retailing business. Project Y is a similarly sophisticated working capital and inventory control system based upon a powerful personal computer and general purpose PC software. Each project has a cost of $10,000, and the cost of capital for both projects is 12%. The projects’ expected net cash flows are as follows:

Expected  Net  Cash Flow

Year                                                                       Project X                                                                                 Project Y

 

0

($10,000)

($10,000)

1

6,500

3,500

2

3,000

3,500

3

3,000

3,500

4

1,000

3,500

 

A.   Calculate each project’s nominal payback period, net present value (NPV), internal rate of return (IRR), and profitability index (PI).

B.    Should both projects be accepted if they are interdependent?

C.    Which projects should be accepted if they are mutually exclusive?

 

 

 

 

 

 

 

 

D.   How might a change in the cost of capital produce a conflict between the NPV and IRR rankings of these two projects? At what values of k would this conflict exist? (Hint: Plot the NPV profiles for each project to find the crossover discount rate k.)

E.    Why does a conflict exist between NPV and IRR rankings?

 

 

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