A firm has $100 million available for capital expenditures. It is considering investing in one of two

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A firm has $100 million available for capital expenditures. It is considering investing in one of two projects; each has a cost of $100 million. Project A has an IRR of 20 percent and an NPV of $9 million. It will be terminated at the end of 1 year at a profit of $20 million, resulting in an immediate increase in earnings per share (EPS). Project B which cannot be postponed has an IRR of 30 percent 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 the one described here influence a firm's decision to use payback as a part of the capital budgeting process?

Capital Budgeting
Capital budgeting is a practice or method of analyzing investment decisions in capital expenditure, which is incurred at a point of time but benefits are yielded in future usually after one year or more, and incurred to obtain or improve the...
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Fundamentals of Financial Management

ISBN: 978-0324272055

10th edition

Authors: Eugene F. Brigham, Joel F. Houston

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