Question

P12.1A (LO 1, 2,5), AN U3 Company is considering three long-term capital investment proposals. Each investment has a useful life of 5 years. Relevant data on each project are as follows. FAZIA (101, 2, 3). A Compute annual rate of return, cash payback, and net present value. Excel Project Bono $160,000 Project Edge $175,000 Project Clayton $200,000 Capital investment Annual net income: Year 1 14,000 14,000 14,000 14,000 14,000 $ 70,000 18,000 17,000 16,000 12,000 9,000 $ 72,000 27,000 23,000 21,000 13,000 12,000 $ 96,000 Total Depreciation is computed by the straight-line method with no salvage value. The company's cost of cap- ital is 15%. (Assume that cash flows occur evenly throughout the year.) Instructions a. Compute the cash payback period for each project. (Round to two decimals.) b. Compute the net present value for each project. (Round to nearest dollar.) c. Compute the annual rate of return for each project. (Round to two decimals.) (Hint: Use average annual net income in your computation.) d. Rank the projects on each of the foregoing bases. Which project do you recommend? b. E $(7,312); C $2,163

Answer 1

PROJECT BONO

Present value of cash inflows = $154,200

Year 1 Year 2 Year 3 Year 4 Year 5 Annual Net Depreciation Discounting Presevt value Income expenses Cash Inflow factor @ 15% of cash flows 14000 32000 460001 0.869565217 40000 14000 32000 46000 0.756143667 34782.6087 14000 32000 460001 0.657516232] 30245.74669 14000 32000 460001 0.571753246 26300.6493| 14000 32000 460001 0.497176735 22870.12982 154199.1345

(a) Cash payback period = Capital Investment / Annual cash Inflow

= $160,000 / $46,000

= 3.478 years

(b) Present Value of project = Present value of cash inflows - Present Value of cash outflow

= $154,200 - $160,000

= -$5,800

(c) Annual rate of return = (Annual Cash flow * 100) / Capital Investment

= ($46,000 * 100) / $160,000

= 28.75%

PROJECT EDGE

Year 1 Year 2 Year 3 Year 4 Year 5 Annual Net Depreciation Discounting Presevt value Income expenses Cash Inflow factor @ 15% (of cash flows 18000 35000 530001 0.86956521746086.95652) 17000 35000 52000 0.7561436671 39319.4707 16000 35000 51000 0.657516232 33533.32785 12000 35000 470001 0.571753246 26872.40254 9000 35000 44000 0.497176735 21875.77635 167687.934

Year 1 Year 2 Year 3 Year 4 Year 5 Capital Bal. of Capital Cash Inflow Investment Investment 5 3000| 175000 122000 52000 122000 70000 51000 70000 19000 47000 19000 44000

(a) Payback period = 3 + ($19,000 / $47,000)

= 3 + 0.404

= 3.404 years

(b) Net Present Value = Present Value of Cash Inflows - Present Value of capital investment

= $167,688 - $175,000

= -$7,312

(c) Annual Rate of Return = (Average Cash flows * 100) / Capital Investment

= ($49,400 * 100) / $175,000

= 28.228%

PROJECT CLAYTON

(a) Payback period = 3 + ($9,000 / $53,000)

Year 1 Year 2 Year 3 Year 4 Year 5 Annual Net Depreciation Discounting Presevt value Income expenses Cash Inflow factor @ 15% (of cash flows 27000 40000 670001 0.8695652171 58260.86957 23000 40000 630000.7561436671 47637.05104 21000 40000 61000] 0.657516232 40108.49018 13000 40000 53000] 0.57175324630302.92202 12000 40000 520001 0.497176735 25853.19024 296000 202162.523 Year 1 Year 2 Year 3 Year 4 Year 5 Capital Bal. of Capital Cash Inflow investment Investment 67000 200000 133000 63000 133000 70000 61000 70000 9000 53000 9000 52000

= 3 + 0.1698

= 3.17 years

(b) Net Present Value = Present Value of Cash Inflows - Present Value of capital investment

= $202,163 - $200,000

= $2,163

(c) Annual Rate of Return = (Average Cash flows * 100) / Capital Investment

= ($59,200 * 100) / $200,000

= 29.6%

(d)

We will recommend Project Clayton.

Ranking Ranking Ranking Pay Back Period 3.48 3.404 3.17 Project Bono Project Edge Project Clayton Annual Rate of Return 28.75% 28.23% 29.60% NPV $ -5,800.00 $ -7,312.00 $ 2,163.00 1L III