VEGETRON’S CFO CALLS AGAIN

Minicase solution, Chapter 5

Principles of Corporate Finance, 12th Ed.

R. A. Brealey, S. C. Myers and F. Allen

The high-temperature process produces $110,000 per year for 5 years. The low-
temperature process produces $85,000 per year for 7 years. Each costs $400,000. The
NPVs (at 9%) and IRRs are:
NPV IRR
High-temperature +$28,000 11.7%
Low-temperature +$28,000 11%

The NPVs are identical. The high-temperature process has a slightly higher IRR because
of its quicker payback.
The CFO returns 30 minutes later:
CFO: What did you find out?
You: It’s a dead heat. The two projects are equally valuable. NPV is +$28,000 for each.
The high-temperature process has a slightly higher DCF rate of return, but that’s typical
of quick-payback projects. It doesn’t mean that the high-temperature process generates
more value for the firm and its stockholders.
CFO: And the book rates of returns are irrelevant?
You: Yes. There’s not a single year when the book rate of return matches the true, DCF
rate of return. Average book returns – for example the ratio of average income to average
book investment – don’t measure the true rate of return. Book rates of return don’t help at
all in making good capital investment decisions.
CFO: Let’s stick with the low-temperature process. I’m not 100% confident that the
high-temperature process will work.

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