Evaluating a Single Project ILOs: A1, A2, A3, B3, C1, C2, C3, D1, D2, D3, D4 The essence of capital budgeting and resource allocation is a search for good investments in which to place the firm's capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital- budgeting analyst is necessarily, therefore, a detective who must winnow good evidence from bad. Much of the challenge is knowing what quantitative analysis to generate in the first place. Suppose you are a new capital-budgeting analyst for a company considering investments in the eight projects listed in Exhibit 1. The chief financial officer (CFO) of your company has asked you to rank the projects and recommend the "four best" that the company should accept. In this assignment, only the quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive. All the projects require the same initial investment, $2 million. Moreover, all are believed to be of the same risk class. The weighted-average cost of capital (WACC) of the firm has never been estimated. In the past, analysts have simply assumed that 10 percent was an appropriate discount rate (although certain officers of the company have recently asserted that the discount rate should be much higher). To stimulate your analysis, consider the following questions: 4. What kinds of real investment projects have cash flows similar to those to Exhibit 1?

Project Free Cash Flows (dollars in thousands)

Exhibit 1

Project number: Year 1 2 330 3 330 4 330 5 330 6 330 7 330* 8 1,000 9 10 11 12 13 14 15 12345678 Initial investment $(2,000) $(2,000) $(2,000) $(2,000) $(2,000) $(2,000) $(2,000) $(2,000) 330 1,666 334* 165 160 280 200 280 350 280 395 280 432 280 440* 280 442 280 444 280* 446 280 448 280 450 280 451 280 451 280 452 280 10,000* (2,000) 280 2.200* 1,200 900* (60) 300 60 90 350 70 700 1,200 2,250* (350) Sum of cash-flow benefits $ 3,310 $ 2,165 $I0, 000 $ 3,561 $4,200 $2,200 $2,560 $ 4,150 Excess of cash flow over initial investments $ 1,310 $ 165 $ 8.000 $ 1,561 $2,200 $ 200 $ 560 $ 2,150 (*) Indicates year in which payback is accomplished.

Answer Q 4 Only and give a recommendations to the CFO of the company of what to do