Question

This is a cost accounting problem, please show all work.

Payback and NPV methods, no income taxes. (CMA, adapted) Andrews Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year. The capital budget is limited to $5,000,000 for the year. Lori Bart, staff analyst at Andrews, is preparing an analysis of the three projects under consideration by Corey Andrews, the company's owner. Insert Page Layout Formulas Data Review View Home A В С D Project C Project A Project B 2 Projected cash outflow 3 Net initial investment $3,000,000 $1,500,000 $4,000,000 4 5 Projected cash inflows: 6 Year 1 7 Year 2 Year 3 9 Year 4 $ 400,000 900,000 800,000 $1,000,000 1,000,000 $2,000,000 2,000,000 200,000 100,000 1,000,000 1,000,000 10 11 Required rate of return 10% 10% 10% Required: 1. Because the company's cash is limited, Andrews thinks the payback method should be used to choose between the capital budgeting projects a. What are the benefits and limitations of using the payback method to choose between projects? b. Calculate the payback period for each of the three projects. Ignore income taxes. Using the payback method, which projects should Andrews choose? 2. Bart thinks that projects should be selected based on their NPVS. Assume all cash flows occur at the end of the year except for initial investment amounts. Calculate the NPV for each project Ignore income taxes 3. Which projects, if any, would you recommend funding? Briefly explain why

Answer 1

03. The NPV approach is the most intuitive and accurate valuation approach to Capital expenditure decasions. The NPV rules state that all project which have a positive NPV should be Accepted while those that are negative Should be reject: In this case funde are limited thus Project A and pooJect B will be selected as they will give highest discounted Present value of cashflows Jal camera

a 10% la Pooject al opgestaltet som en forma cash proof -டிய டிடி inidhu inflow inflows ( 6 d and L 16 (axo) (axco 1,000,000 109000 400,000 363600 2,000,000 1,818,000 1 0 .909 0.826 1,000,000 826000 900,000 743400 2,000,000 1,652,000 0.751 1000.000 751000 800,000 600800 200.000 150200 14 0.683 1,000,000 683000. - 100.000 68300 Totae pucy 3169000 6707,800 3688500 cash flows Il Pv ces I cash outflow (30000)| (1:50000) (4,000,000) Neoposent 169000 2078001 $(311500) value (I - I Pooject B will be selected as it has highest NPV as compared to project A and c

Pooject c cash inflow 2,000,000 2,00, con 200, co 100, ar Cumalative cash inflow 2,000, oso yoooooo 4,2 0.0000 4300,00 no s Pay back Period 2+ 4ooooo -4or, aro 20012oo 3 ayrs. Accooding to payback period Andrews Should choose Project c as it has least pay bach Period:

6) calculation of pay back period :- for even cash flows - Pay back period - Initial investment Net Annual cash inflows. Project A = 3,000,000 Ceven cash 1,000,000 — 348 inflows) तल Project cash inflows 400,000 900.000 800,000 B: Cuneven cashinglows) cum alative cash inglows 400000 1300000 2100000 Pay Back s completed years initial cash Telowin Period before pay investment - completed back years year cashenglow in Pubaiк чал. 2+ 4500000 1300,000 8oo ar 2.25 years.

Benefits & Limitations Of PAY BACK PERIOD Benefits This is the most easy method to be used for evaluation of capital expenditure This method is quite important for those firms which are facing pooblems of ° Cash Shootage and finance their projecte thoough loans Those firme Prelers Projects Of Small Pay-back period Toon Risk al Obsalescence- such projects in which the technological development is Quite fast and there is more sisk obscalescence, then such Projects are chosen in which the Day-back period is very small av more Accurate estimate - In this method we do not consider the life of Project but only the Peolod of pay - back is taken into a consideration. Therefore estimates are more accurate and deal au lo this method Projects of shooter period are Selected therefore there is less rigk Luiz Shetla?ONGmical method as it sequires ipad te mume and effoot of project evalvator

om the non limit otions- There is more impootance to liquidity xather than to the Prcelitabiuty which not right : Too much emphasis is given Pay back of Original investment Info 4.000 6. XX 8.00 47. : o The Alpha lij lternative i indows are Year This method does not consider the income received after pay back period The objectiu of any from to invast money in capita Projects is not only to get the investmen back but to eaon Safit therefore earning in the entire life of the Projecť should be considered he company 6 respective 1. NPV a re are two ected cash i The cast of capital is the strong basis of Investment' decesion but this meth&d ignores cost of capital This method does not consider the scrap I value of any Capital asset. tw e cut-o! PV of itually infor W There is more emphasise on cash inflows of initial years and no importance is given to income deceived in later years. OSL (V1) This method does not consider the time factor ast of cash ingcous. It is quite important to know the prosent value of future caghingious foom diferent projects to make them comparable ntent to bene factor future co