Bright Tiles Limited (BTL) has been expanding very rapidly in recent years, making its shareholders rich in the process. The average annual rate of return on the stock in the past few years has been 22%, and BTL managers believe that 22% is a reasonable figure for the firm’s cost of capital. To sustain a high growth rate, BTL’s 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 involves modernization of the firm’s existing production facility, and the second is an expansion of its production capability.

Cash flows from each project appear below.

a. Calculate the NPV, IRR, and PI for both projects.

b. Rank the projects based on their NPV, IRR, and PIs.

c. Do the rankings in part b agree or not? If not, why not?

d. The firm can undertake only one investment, and the CEO favors the expansion project because it offers a higher rate of return (i.e., a higher IRR) than the modernization project. What do you think the firm should do? Why?

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Year 0 1 2 3 4 Modernization -2,200,000 900,000 1,500,000 1,500,000 1,700,000 Expansion -3,000,000 1,500,000 2,000,000 2,200,000 2,100,000