Question

Vanguard is evaluating new potential investments to add to their international investment fund. Their current fund composition boasts returns that, on average, exceed the S&P 500 at 8.5%. They take a conservative approach by allowing capital investments to be recovered within a decade following each purchase. Vanguard is considering adding the Hungarian firm, Kimco & Company, a new technology firm developing automation software for the automotive industry, to their fund.
Estimated details regarding the Kimco & Co. investment are as follows:

Potential investment Payback period Return on investment (ROI) Net present value (NPV) Internal rate of Return (IRR)
Kimco & co. 7 years 0.079 0 0.085

Required:
As an analyst at Vanguard, would you recommend adding Kimco & co. to their international fund?

Answer 1

Answer:

No, I would NOT recommend adding Kimco & co. to their international fund.

Explanation:

The following analyses have to be considered first before making a recommendation:

1. The decision rule for Payback period is to accept a project if its estimated payback period is less than the benchmark payback period. In this question, the estimated Potential investment Payback period of 7 years is less than the 10 years provided by conservative approach. Therefore, the project should be accepted based on Payback period.

2. The decision rule for Return on investment (ROI) is to reject a project if its estimated ROI is less than the average returns. In this question, the estimated ROI of 7.90% is less than the average returns of 8.50%. Therefore, the project should be rejected based on ROI.

3. The decision rule for Net present value (NPV) is to reject a project if its NPV is positive and reject if negative. In this question, the NPV is not neither positive nor negative but zero. Therefore, decision cannot be taken based on NPV.

4. The decision rule for Internal rate of Return (IRR) is to reject a project if its IRR is less than its associated average returns. In this question, the estimated IRR is not less than the average returns because they are both equal to 8.5%. Therefore, decision cannot be taken based on IRR.

Recommendation

No, I would NOT recommend adding Kimco & co. to their international fund based on the ROI.

Although the project should be accepted based on Payback period, but the ROI will still be less than the average return despite that estimated Potential investment Payback period of 7 years is less than the 10 years provided by conservative approach.

Therefore, Kimco & co. should NOT be added to their international fund.