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.