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Accounting and decision making. Salomon Company uses a cost of capital rate of 12 percent in making investment decisions. It currently is considering two mutually exclusive projects, each requiring an initial investment of $10 million. The first project has a net present value of $21 million and an internal rate of return of 20 percent. The firm will complete this project within one year. It will raise accounting income and earnings per share almost immediately thereafter. The second project has a net present value of $51 million and an internal rate of return of 30 percent. The second project requires incurring large, non-capitalizable expenses over the next few years before net cash inflows from sales revenue result. Thus accounting income and earnings per share for the next few years will not only be lower than if the first project is accepted but will also be lower than earnings currently reported.
a. Should the short-run effects on accounting income and earnings per share influence the decision about the choice of projects? Explain.
b. Should either of the projects be accepted? If so, which one? Why?
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