Role of Capital Market

Since there is a lot of uncertainty related to PJ2 and PJ3 Baron has decided to use a larger risk-adjusted discount rate, expecting a higher return due to the higher risk. In the replacement decision the NPV values play the main role, since this method has proved to be the most accurate one, especially when the projects are mutually exclusive. The option B has the highest NPV and is therefore the one that should be selected. All of the three options have positive NPV values, so theoretically any one of them could be undertaken, but the one with the highest NPV benefits the firm the most. The decision can also be made by considering IRR values or by using some other methods, but NPV method is the most advantageous. In this problem we have a 15-year period, so the fact that NPV takes time value into account is important. It is also a direct measure of the dollar contribution to shareholders. The method is easily comparable and customizable, because the discount rate adjustments can be made. Drawbacks of this method are the following: finding the appropriate discount rate might be difficult, it might not give accurate decisions when the projects have unequal length of life and when mutually exclusive projects don’t represent equal amounts of investment. He assumed that the competitors will definitely switch to PJ2 or PJ3 and that’s why they must follow. They thought that there will no significant change in the market share in the future, but they presumed that being the preference of the passengers will make some change, if any, in the market share. They also believed that the price of fuel is going to determine which one of the two new aircraft types is more efficient. The decisions mentioned above are the ones our group has chosen to make.