The Fun Foods Corporation must decide on what new product lines to introduce next year. After-tax cash flows are listed below along with initial investments. The firm’s cost of capital is 12 percent and its target accounting rate of return is 20 percent. Assume straight-line depreciation and an asset life of five years. The corporate tax rate is 35 percent. All projects are independent.
Project Investment Year 1 2 3 4 5
A 5,000 800 1000 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
b. Calculate the payback period. All projects with a payback of fewer than four 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?
e. Which projects should be chosen?