As chief financial officer, it is your responsibility to weigh financial pros and cons of the many investment opportunities developed by your company's research and development division. You are currently evaluating two competing 15-year projects that differ in several ways. Relative to your firm's current EPS, the first project is expected to generate above-average EPS during the first 5 years, average EPS during the second 5 years, and then below-average EPS in the last 5 years. The second project is expected to generate below-average EPS during the first 5 years, average EPS in the second 5 years, and then well-above-average EPS in the last 5 years. Is the choice obvious if you expect that the second investment will result in a larger overall earnings increase?
Given the goal of the firm, what issues will you consider before making a final decision?
Is the choice obvious if you expect that the second investment will result in a larger overall earnings increase?

a) The choice is not obvious even if I expect that the second investment will result in a larger overall earnings increase. The volume and value of the cash flows are not disclosed in this instance. Earnings are not the same as cash flows.

b) The timing, volume, and cash flows are very important issues here. Because of the time value of money, the second choice with its larger overall earnings may not necessarily be the better choice. This is because its cash flows are delayed relative to the first choice.

c) However, since the consideration centers around the EPS (Earnings Per Share), the company's goal will be to grow the EPS. This goal favors the second choice that bears more increasing earnings year-on-year than the first choice.

Explanation:

a) Data and Checks:

1st Project:

During first 5 years, above-average EPS

During second 5 years, average EPS

During last 5 years, below-average EPS

2nd Project:

During first 5 years, below-average EPS

During second 5 years, average EPS

During last 5 years, well-above average EPS

Company's goal:

Grow the EPS