Problem 6: Johnny Walker, the general manager of the Eastern Tool Company, is considering introducing some new tools to the company's product line. The top management of the firm has identified three types of tools (referred to as projects A, B and C). The various divisions of the firm have provided the data given in the following table on these three possible projects. The company has a limited capital budget of $2.4 million for the coming year.

Project A Project B Project C

Present value of net cash flows ($) $3,000,000 $1,750,000 $1,400,000

Initial cost of the project 2,400,000 1,300,000 1,100,000

Net present value($)

(A)Which project(s) would the firm undertake if it used the net present value (NPV) investment criterion?

(B)Is this the correct decision? Why?

project A project B Project C

Present value of net cash flows $3,000,000 $1,750,000 $1,400,000

Initial cost of the project -2,400,000 -1,300,000 -1,100,000

IRR

Going by the IRR method, project B should be adopted by the firm because it gives the highest return compared to the other projects and also falls well within budget leaving the firm with extra capital of$650,000 i.e. 2,400,000 - 1,750,000 = $650,000 which can be invested in other projects