Question

# oug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of \$27,500....

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 \$8,750 \$12,500 \$16,250 Unresolved 12,500 15,000 15,000 12,500 13,750 \$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 BB Enter a number of years rounded to 2 decimal places years Enter a number of years rounded to 2 decimal places years 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 enter a dollar amount rounded to 0 decimal places 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

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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