Question

Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $26,840. Each project will last for 3 years and produce the following net annual cash flows.

Year		AA		BB		CC
1		$8,540		$12,200		$15,860
2		10,980		12,200		14,640
3		14,640		12,200		13,420
Total		$34,160		$36,600		$43,920

The equipment’s salvage value is zero, and Doug uses straight-line depreciation. Doug will not accept any project with a cash payback period over 2 years. Doug’s required rate of return is 12%. Click here to view PV table.

(a)

Compute each project’s payback period. (Round answers to 2 decimal places, e.g. 15.25.)

AA		enter the payback period in years rounded to 2 decimal places	years
BB		enter the payback period in years rounded to 2 decimal places	years
CC		enter the payback period in years rounded to 2 decimal places	years

Which is the most desirable project?

The most desirable project based on payback period is

select the most desirable project based on payback period                                                          Project AAProject BBProject CC

Which is the least desirable project?

The least desirable project based on payback period is

select the least desirable project based on payback period                                                          Project BBProject AAProject CC

(b)

Compute the net present value of each project. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45). Round final answers to the nearest whole dollar, e.g. 5,275. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

AA		enter the net present value in dollars rounded to the nearest whole
BB		enter the net present value in dollars rounded to the nearest whole
CC		enter the net present value in dollars rounded to the nearest whole

Which is the most desirable project based on net present value?

The most desirable project based on net present value is select the most desirable project based on the net present value                                                          Project BBProject AAProject CC.

Which is the least desirable project based on net present value?

The least desirable project based on net present value is select the least desirable project based on the net present value                                                          Project BBProject AAProject CC.

Answer 1

Solution a:

Computation of Cumulative Cash flows
Period	AA		BB		CC
	Cash inflows	Cumulative Cash Inflows	Cash inflows	Cumulative Cash Inflows	Cash inflows	Cumulative Cash Inflows
1	$8,540.00	$8,540.00	$12,200.00	$12,200.00	$15,860.00	$15,860.00
2	$10,980.00	$19,520.00	$12,200.00	$24,400.00	$14,640.00	$30,500.00
3	$14,640.00	$34,160.00	$12,200.00	$36,600.00	$13,420.00	$43,920.00

Payback period:

Project AA = 2 years + ($26840 - $19520) / $14640 = 2.50 years

Project BB = $26840 / $12200 = 2.20 years

Project CC =  1 year + ($26840 - $15860) / $14640 = 1.75 years

Most desirable project based on payback period is "Project CC"

Least desirable project based on payback period is "Project AA"

Solution b:

Computation of NPV - Doug Custom
			Project AA		Project BB		Project CC
Particulars	Period	PV Factor	Amount	Present Value	Amount	Present Value	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$26,840	$26,840	$26,840	$26,840	$26,840	$26,840
Present Value of Cash outflows (A)				$26,840		$26,840		$26,840
Cash Inflows
Year 1	1	0.89286	$8,540.00	$7,625	$12,200.00	$10,893	$15,860.00	$14,161
Year 2	2	0.79719	$10,980.00	$8,753	$12,200.00	$9,726	$14,640.00	$11,671
Year 3	3	0.71178	$14,640.00	$10,420	$12,200.00	$8,684	$13,420.00	$9,552
Present Value of Cash Inflows (B)				$26,799		$29,302		$35,384
Net Present Value (NPV) (B-A)				-$41		$2,462		$8,544

Most desirable project based on NPV is Project "CC"

Least desirable project based on NPV is Project "AA"