Rico Company has been growing very rapidly in recent years making it shareholders rich in the

QUESTION

Rico Company has been growing very rapidly in recent years, making it shareholders rich in the process. The average annual rate of return on the stock in the last few years has been 20% and the last few years has been 20%, and Rico managers believe that 20% is a reasonable figure for the firms cost of capital. To sustain a high growth rate, the Rico CEO argues that the company must continue to invest in projects that offer the highest possible rate of return. Two projects are currently under review. The first is an expansion of the firms production capacity, and the second project involves introducing one of the firms existing products into a new market. cash flows from each project appear in the table.A. Calculate the NPV, IRR, and PIB.Rank the projects based on NPV IRR and PI.C.Do the rankings in part B agree or not? If not, why not?D.The firm can only afford to undertake one of these investments , and the CEO favors the product introduction because it offers a higher rate of return ( that is, a higher IRR) than the plant expansion. What do you think the firm should do? Why?Year Plant Expansion Plant Introduction0 -3,500,000 -500,0001 1,500,000 250,0002 2,000,000 350,0003 2,500,000 375,0004 2,750,000 425,000
Cost of capital 20% A. Plant Expansion Year Cash Flows Present Value factor @ 20% Present value of cash flows (20%) Present value factor @ 43% Present value of cash flows (43%) 0 (3,500,000) 1.0000 -3500000.00 1.0000 -3500000.00 1 1,500,000 0.8333 1250000.00 0.6993 1048951.05 2 2,000,000 0.6944 1388888.89 0.4890 978042.94 3 2,500,000 0.5787 1446759.26 0.3420 854932.64 4 2,750,000 0.4823 1326195.99 0.2391 657640.49 Total 1911844.14 39567.11 Net Present Net Prsent

Value (NPV) Present Value of cash inflows-Present value of cash outflows Net Prsent Value (NPV) 1,911,844.14 Internal Rate of return Internal rate of return = Lower rate + (NPV at lower rate/(NPV at Lower rate-NPV at higher rate))* Difference between two rates Internal rate of return 43.70 % Profitability index

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