Question

Integrativelong dash—Conflicting

Rankings???The? High-Flying Growth Company? (HFGC) has been growing very rapidly in recent? years, making its shareholders rich in the process. The average annual rate of return on the stock in the last few years has been 19?%, and HFGC managers believe that 19?% is a reasonable figure for the? firm's cost of capital. To sustain a high growth? rate, the HFGC CEO argues that the company must continue to invest in projects that offer the highest rate of return possible. Two projects are currently under review. The first is an expansion of the? firm's production? capacity, and the second project involves introducing one of the? firm's existing products into a new market. Cash flows from each project appear in the following? table:

Year		Plant expansion		Product introduction
0		??$3,800,000		??$500,000
1		?$1,500,000		?$375,000
2		?$2,750,000		?$300,000
3		?$3,000,000		?$350,000
4		?$2,000,000		?$400,000

Answer 1

For plant expansion proposal

Statement Showing NPV

Year	Cash flow	PVIF @ 19%	Present Value
0	-3800000	1.0000	-3800000
1	1500000	0.8403	1260504
2	2750000	0.7062	1941953
3	3000000	0.5934	1780247
4	2000000	0.4987	997338
NPV			2180042

PI = PV of cash inflow/PV of cash outflow

=5980042/3800000

=1.547

For production itroduction proposal

Statement Showing NPV

Year	Cash flow	PVIF @ 19%	Present Value
0	-500000	1.0000	-500000
1	375000	0.8403	315126
2	300000	0.7062	211849
3	350000	0.5934	207696
4	400000	0.4987	199468
NPV			434139

PI =934139/500000

=1.87

Thus project indroduction should be done as it provide more return than plant expansion. If considering firm's value then plant expansion should be done as NPV is more than project indroduction