Pearland Medical Center is considering two proposed capital investment opportunities, Project A and Project B. Each project requires a net investment of $100,000. The cost of capital for each project is 12 percent. The projects’ expected cash revenues are:
Year Project A Project B
0 ($100,000) ($100,000)
1 $62,500 $32,625
2 $30,000 $32,625
3 $28,000 $32,625
4 $10,000 $32,625
Calculate each project’s payback period, net present value, and internal rate of return. Explain which project is financially acceptable.
Avery, Flaherty, and Rhee (2011) noted that when choosing a capital budgeting decision tool, academics recommend NPV as the primary approach followed by IRR. What are the advantages and disadvantages of NPV and IRR methods in regards to profitability analysis in evaluating investment decisions?
Why are firms using the payback period method as a primarily decision-making tool?