Question

oug’s Custom Construction Company is considering three new
projects, each requiring an equipment investment of $27,500. Each
project will last for 3 years and produce the following net annual
cash flows.

Year |
AA |
BB |
CC |
||||
---|---|---|---|---|---|---|---|

1 | $8,750 | $12,500 | $16,250 | ||||

2 | Unresolved | 12,500 | 15,000 | ||||

3 | 15,000 | 12,500 | 13,750 | ||||

Total | $35,000 | $37,500 | $45,000 |

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 the factor table.

**(a)**

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

AA | Enter a number of years rounded to 2 decimal places | years | |
---|---|---|---|

BB | Enter a number of years rounded to 2 decimal places | years | |

CC | Enter a number of years rounded to 2 decimal places | years |

Which is the most desirable project?

The most desirable project based on payback period is | select a project Project AAProject BBProject CC |

Which is the least desirable project?

The least desirable project based on payback period is | select a project 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 a dollar amount rounded to 0 decimal places | ||
---|---|---|---|

BB | enter a dollar amount rounded to 0 decimal places | ||

CC | enter a dollar amount rounded to 0 decimal places |

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

The most desirable project based on net present value is select a project Project CCProject BBProject AA. |

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

The least desirable project based on net present value is select a project |

Answer #1

a.) Given in the question

Year/ project | AA | BB | CC |

1 | 8750 | 12500 | 16250 |

2 | 11250* | 12500 | 15000 |

3 | 15000 | 12500 | 13750 |

Total | 35000 | 37500 | 45000 |

* balancing figure

Now, Calculation of payback period

Year/ project | AA | Cumulative inflow | BB | Cumulative inflow | CC | Cumulative inflow |

1 | 8750 | 8750 | 12500 | 12500 | 16250 | 16250 |

2 | 11250* | 20000 | 12500 | 25000 | 15000 | 31250 |

3 | 15000 | 35000 | 12500 | 37500 | 13750 | 45000 |

Total | 35000 | - | 37500 | - | 45000 | - |

Initial investment | 27500 | 27500 | 27500 | |||

Payback period lies between | Year 2 and 3 | Year 2 and 3 | Year 1 and 2 | |||

Payback period | 2 yr +(27500-20000)/15000 | 2 yr +(27500-25000)/12500 | 1yr+ (27500-16250)/15000 | |||

2.5 year | 2.2 year | 1.75 year |

So, payback period of project CC is least. hence it should be selected. Most desirable project would be CC and least desiarble would be Project AA with highest payback time.

B. Calculation of NPV

Working note. Discounting factor for year 1 is 0.8929, for year 2 is 0.7972 and for year 3 is 0.7118 @12% expected return

Particulars | AA | BB | CC |

Investment (A) | 27500 | 27500 | 27500 |

Year 1 discounted inflow @0.8929 | 0.8929*8750=7812.88 | 0.8929*12500=11161.25 | 0.8929*16250=14509.63 |

Year 2 discounted inflow @0.7972 | 0.7972*11250=8968.5 | 0.7972*12500=9965 | 0.7972*15000=11958 |

Year 3 discounted inflow @0.7118 | 0.7118*15000=10677 | 0.7118*12500=8897.5 | 0.7118*13750=9787.25 |

Total inflow (B) | 27458.38 | 30023.75 | 36254.88 |

NPV (B-A) | 458.38 | 2523.75 | 8754.88 |

So, NPV of project CC is highest. hence it should be selected. Most desirable project would be CC and least desiarble would be Project AA with least NPV.

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Year
AA
BB
CC
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$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
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