Assume that for a car manufacturer, Chrysler Ford. Your boss, the chief financial officer, has just handed you the estimated cash flows for two proposed projects. Project L involves adding a new item to the firms ignition line; it would take some time to build up the market for this product, so the cash inflows would increase over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 3-year lives, because Chrysler is planning to introduce entirely new models after 3 years.
Here are the projects net cash flows (in thousands of dollars):
The CFO also made subjective risk assessments of each project, and he concluded that both projects have characteristics which are similar to the firms average project. Chrysler’s weighted average cost of capital is 10%. You must no determine whether one or both of the projects should be accepted.
Evaluate the projects using the 5 key techniques: (1) payback period, (2) discounted payback period, (3) net present value, (4) internal rate of return, and (5) modified internal rate of return. Identifythose projects that will lead to the maximization of the firms stock price.
Payback period is the time in which the initial outlay of an investment is expected to be recovered through the cash inflows generated by the investment. It is one of the simplest investment appraisal techniques.
Critically appraise the appraisal techniques above. Discuss their limitations, the social and ethical factors that should also be considered when making such decisions.