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. a. Should the short-run effects on EPS influence the choice between the two projects? b. How might situations like this influence a firm’s decision to use payback?
Fundamentals of Financial Manageme...
Fundamentals of Financial Manageme...
Solutions
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.
- a. Should the short-run effects on EPS influence the choice between the two projects?
- b. How might situations like this influence a firm’s decision to use payback?
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