Question

Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $23,320. Each project will last for 3 years and produce the following net annual cash flows.

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%.

Doug's Custom Construction Company is considering three new projects, each requiring an equipment investment of $23,320. Each project will last for 3 years and produce the following net annual cash flows. Year 1 2 3 Total AA $7,420 9 ,540 12,720 $29,680 BB $10,600 10,600 10,600 $31,800 CC $13,780 12,720 11,660 $38,160 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.) АА years BB years years Which is the most desirable project? The most desirable project based on payback period is Project AA Project BB Project CC Which is the least desirable project? The least desirable project based on payback period is

Answer 1

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	$7,420.00	$7,420.00	$10,600.00	$10,600.00	$13,780.00	$13,780.00
2	$9,540.00	$16,960.00	$10,600.00	$21,200.00	$12,720.00	$26,500.00
3	$12,720.00	$29,680.00	$10,600.00	$31,800.00	$11,660.00	$38,160.00

Payback period:

Project AA = 2 years + ($29,680 - $23,320) / $12,720 = 2.50 years

Project BB = $23,320 / $10,600 = 2.20 years

Project CC = 1 year + ($23,320 - $13,780) / $12,720 = 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	$23,320	$23,320	$23,320	$23,320	$23,320	$23,320
Present Value of Cash outflows (A)				$23,320		$23,320		$23,320
Cash Inflows
Year 1	1	0.89286	$7,420.00	$6,625	$10,600.00	$9,464	$13,780.00	$12,304
Year 2	2	0.79719	$9,540.00	$7,605	$10,600.00	$8,450	$12,720.00	$10,140
Year 3	3	0.71178	$12,720.00	$9,054	$10,600.00	$7,545	$11,660.00	$8,299
Present Value of Cash Inflows (B)				$23,284		$25,459		$30,743
Net Present Value (NPV) (B-A)				-$36		$2,139		$7,423

Most desirable project based on net present value is Project CC

:Least desirable project based on net present value is Project AA