Question: (Determining a firm's capital budget) Newcomb Vending Company manages soft drink dispensing machines in western Tennessee for several of the major bottling companies in the area. When a machine malfunctions, the company sends out a repair technician; if he cannot repair it on the spot, he puts in a replacement machine so thatthe broken one can be taken to the firm's repair facility in Murfreesboro, Tennessee. Betsy Newcomb recently completed her BBA from a nearby university and has been trying to incorporate as much of what she learned as possible into the operations of her family business. Specifically, Betsy recently reviewed the firm's capital structure and estimated that the firm's weighted average cost of capital is approximately 12 percent. She hopes to help her father determine which of several major capital expenditures he should make in the current year based on a comparison of the rates of return she estimated for each project (that is, the compound annual rate of return earned on the investment over its life) and the firm's cost of capital. Specifically, the firm is considering the following projects (ranked by their internal rate of return):
If all five of the investments being considered by Newcomb are of similar risk and that risk is very similar to that of the company as a whole, which project(s) should Betsy recommend the firm undertake? You may assume that the firm can raise all the capital it needs to fund its investments at the cost of capital of 12 percent. Explain your answer.