A firm has a $100 million capital budget. It is considering two projects, each costing $100 million. Project A has an IRR of 20% and an NPV of $9 million; it will be terminated after 1 year at a profit of $20 million, resulting in an immediate increase in EPS. Project B, which cannot be postponed, has an IRR of 30% and an NPV of $50 million. However, the firm’s short-run EPS will be reduced if it accepts Project B because no revenues will be generated for several years. Should the short-run effects on EPS influence the choice between the two projects? How might situations like this influence a firm’s decision to use payback?

A firm has a $100 million capital budget. It is considering two projects, each costing $100 million. Project A has an IRR of 20% and an NPV of $9 million; it will be terminated after 1 year at a profit of $20 million, resulting in an immediate increase in EPS. Project B, which cannot be postponed, has an IRR of 30% and an NPV of $50 million. However, the firm’s short-run EPS will be reduced if it accepts Project B because no revenues will be generated for several years. Should the short-run effects on EPS influence the choice between the two projects? How might situations like this influence a firm’s decision to use payback?

Principles of Accounting Volume 2

19th Edition

ISBN:9781947172609

Author:OpenStax

Publisher:OpenStax

Chapter11: Capital Budgeting Decisions

Section: Chapter Questions

Problem 2PB: Markoff Products is considering two competing projects, but only one will be selected. Project A...

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Markoff Products is considering two competing projects, but only one will be selected. Project A requires an initial investment of $42,000 and is expected to generate future cash flows of $6,000 for each of the next 50 years. Project B requires an initial investment of $210,000 and will generate $30,000 for each of the next 10 years. If Markoff requires a payback of 8 years or less, which project should it select based on payback periods?
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