Question

(5 pts) You have a board of directors who have asked you which of the three mutually exclusive Drone options you recommend based upon using IRR. You've developed the data in the table below. Describe two additional decision metrics (ie from Ch 5 -- profitability index, payback, etc.) that you would use for this type of decision and describe the arguments you would make to suggest why'they offer a better decision metric for the specific decision. CF oné Options: roject Cost ($ bill) IRR A $125 203% $350 111% $425 184% OFA - 125 = 61.58 203% 350 - 315.32 CFR 425 230.98

Answer 1

Answer 1:

Based on IRR the project that should be selected is Project A which has highest IRR (provided that IRR is greater than cost of capital).

Answer 2:

Two additional decision metrics,you would use are:

1. NPV: NPV is best metric to be used for decision for selection of project from among mutually exclusive projects.

It offers a better decision metric as compared to IRR. IRR suffers from assumption that the cash flows can be reinvested at the rate of IRR. For example based on IRR criteria, we choose project A. Project A has IRR of 203%. This calculation of IRR is based on assumption that cash flows of Project A is reinvested at the rate of 203% which is simply impractical. As such NPV is better criteria for decision when we have to choose project among mutually exclusive projects.

2. Profitability Index (PI): PI could be also additional criteria that can be used when we have to ration capital.

We cannot calculate NPV of these projects since cost of capital is not given.