The Fun Foods Corp. must decide on what new product line to introduce next year. After-tax cash flows are listed below along with initial investments. The firm’s cost of capital is 12% and its target accounting rate of return is 20%. Assume straight-line depreciation and an asset life of five years. The corporate tax rate is 35%. All projects are independent.
Project Investment Year 1 2 3 4 5
A $5,000 $800 $1,000 $350 $1,250 $3,000
B $7,500 $1,250 $3,000 $2,500 $5,000 $5,000
C $4,000 $600 $1,200 $1,200 $2,400 $3,000
a. Calculate the accounting rate of return on the project. Which projects are acceptable according to this criterion? (Note: Assume net income is equal to after-tax cash flow less depreciation)
b. Calculate the payback period. All projects with a payback of fewer than 4 years are acceptable. Which are acceptable according to this criterion?
c. Calculate the projects’ NPVs. Which are acceptable according to this criterion?
d. Calculate the projects’ IRRs. Which are acceptable according to this criterion?