Part 1

Assume that for a car manufacturer, Chrysler Ford. Your boss, the chief financial officer, has just handed you

the estimated cash flows for two proposed projects. Project L involves adding a new item to the firm’s

ignition line; it would take some time to build up the market for this product, so the cash inflows would increase

over time. Project S involves an add-on to an existing line, and its cash flows would decrease over time. Both

projects have 3-year lives, because Chrysler is planning to introduce entirely new models after 3 years.

Here are the projects net cash flows (in thousands of dollars):

Expected after-tax

net cash flows (CFt)                                                                                               Project S

Year (t)      Project S       Project L                                                                       0         1         2          3

0                 ($100)            ($100)                                                                       -100     70       50        20

1                    70                    10

2                    50                    60                                                                          Project L

3                   20                     80                                                                            0         1         2         3

                                                                                                                            -100     10      60        80

Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows.

The CFO also made subjective risk assessments of each project, and he concluded that both projects have risk

characteristics which are similar to the firm’s average project. Chrysler’s weighted average cost of capital is 10%.

You must now determine whether one or both of the projects should be accepted.

Required

Evaluate the projects using the 5 key techniques:

(1) payback period,

(2) discounted payback period,

(3) net present value,

(4) internal rate of return, and

(5) modified internal rate of return.

Identify those projects that will lead to the maximization of the firm’s stock price.

Part 2

Critically appraise the appraisal techniques above. Discuss their limitations, the social and

ethical factors that should also be considered when making such decisions.