Gas Station A should be selected. Under the Net Present Value (NPV) method, the firm should consider gas station A since its NPV of $32,644 is positive and exceeds cash outflows. The NPV value of Gas Station A is higher as compared to $16,115 of Gas Station B. Based on the Internal Rate of Return (IRR) rule, the organization accepts the project having an IRR that is higher than the cost of finance. In this case, the firm should accept Gas Station B IRR equals 41.421%. The internal return rate of Gas Station B is lower than that of Gas Station A and hence cannot be selected. Based on the payback method, Gas Station B has the shortest payback period of one year as compared to two years for Gas Station A.
Depending on the payback period, Gas Station B should be selected. However, the payback period method does not consider the time value of money and also does not take into account extra income beyond the calculated PBP; hence, the selection of the projects cannot be based on this method.
In gauging the profitability of an investment, the NPV method considers all the inflows produced by the venture, and thus, it indicates whether the investment will create value for the organization. The time value of money is considered in this model, and hence, the dollar is compared at its current value. Also, the NPV method considers the cost of capital and inherent risks for future projection. This method is compatible with the maximization of owners’ wealth since an IRR that is higher than the cost of capital reflects higher returns. The interpretation of IRR results is straightforward after calculation, and managers can visualize and select the best ventures easily. Additionally, this model takes into consideration the entire returns of the investment (Juhász, 2011, p. 50).
References
Juhász, L. (2011). Net present value versus internal rate of return. Economics & Sociology, 4(1), 46-53.
