You are considering two possible projects (Project A and Project B) that would start at the beginning of 2020. Your boss has indicated that she only wants to select one of these projects given resource constraints and uncertainties about the economy. She has asked you to evaluate each project and recommend which project you think the company should select. You have made the following forecasts for each project. Project A would require an initial investment of $6.4M (USD) on January 1, 2020 and a second investment of $4M on Jan 1, 2021. The project would break even in the following year (2022) but would earn positive returns of $1.2M, $3.5M, $7.1M, and $12.6M in the following four years.
Project B would require an initial investment of $18M on January 1, 2020 but would not earn (or cost) anything until the end of 2024 when you think it would return approximately $45M.
You estimate that an appropriate annual discount rate is 14 percent based on your company’s future projected performance. Furthermore, the CFO has indicated that there is an inflation rate of 2.5 percent that should be factored into your calculations; he feels that this rate will be fairly constant over the foreseeable future. The CFO has also indicated that the company uses discrete discounting and assumes that all cash flows occur at the end of each year (except for the initial investments).
Your boss indicated that you should consider the inflation rate adjusted NPV, the IRR, and the Profitability Index when comparing these two projects. Based on these metrics, which project would you recommend? What other factors (other than these metrics) might be important when comparing these projects? How would your company’s risk tolerance impact the possible decision?