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. |
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"
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