Question

i need help

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, la preparing an an three projects under consideration by Corey Andrews, the company's owner TE Click the icon to the data for the three projects) Pretty 51 Estre ble B u ty of the Read the requirements Requirement 1. Because the company's cash is limited, Andrews think the payback method should be used to choose between the capital budgeting projects What are the benets and limitations of using the payback method to choose between project? Benefits of the paybackthod OA Utes the time value of money and computes each project's unique rate of retum OB. Indicates whether or not the project leam the company's minimum required to retum OC. Ewy to understand and captures uncertainty about expected cash flows in years of a project D. All of the above O A Carnot be used when management's required rate of retum varies from one period to the next OC. Carnot be used for projects we neque periodic cash flows of the above C e paya pened for each of the tree projects are income taxes. Round you to two decimal places Propeta mars Enter any number on eat holds and then conthus to the next question,

Answer 1

Requirement 1:

Benefit

Correct Option is Option C - Easy to understand and captures uncertainty about expected cashflow in later years of the project

Disadvantage:

Correct Option is Option D - All of the above

Now We will be finding the cumulative cashflows over years.

Project A
Initial Investment		30,00,000
year	Cashflow	Cumulative Cashflow
1	10,00,000	10,00,000
2	10,00,000	20,00,000 (1000000 + 1000000)
3	10,00,000	30,00,000 (2000000 + 1000000)
4	10,00,000	40,00,000

So in year 3 we get all the invested money back i.e. $ 3000000

Hence, total payback period = 3 Years

Project B
Initial Investment		15,00,000
year	Cashflow	Cumulative Cashflow
1	4,00,000	4,00,000
2	9,00,000	13,00,000 (400000 + 900000)
3	8,00,000	21,00,000 (1300000 + 800000)

So in year 2 we get $ 1,300,000 money back of the invested money $ 1,500,000

So remaining money (1500000 - 1300000 ) = $ 200,000 needs to retrieved from year 3.

Now, in year 3 we are earning $ 800,000

Hence, to earn  $ 200000, it will take = $ 200000 / 800000 = 0.25 Years

Hence, total payback period = Year 2 + 0.25 (Year 3) = 3.25 Years

Project C
Initial Investment		40,00,000
year	Cashflow	Cumulative Cashflow
1	20,00,000	20,00,000
2	20,00,000	40,00,000
3	2,00,000	42,00,000
4	1,00,000	43,00,000

So in year 2 we get all the invested money back i.e. $ 4000000

Hence, total payback period = 2 Years

Hence, payback period of Project C is minimum.

Thus, we should choose Project C on the basis of Payback period

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Requirement 2

NPV is given by:

Σ Rt/(1 i)ttvaries from 1 to n NPV where Rt Cash flow netted (Inflow - Outflow) during the period "t" i Discount rate t number of periods

For Project A

NPV = [1000000 / (1 + 10%)^¹] + [1000000 / (1 + 10%)^²] + [1000000 / (1 + 10%)^³] + [1000000 / (1 + 10%)^⁴] - Initial Investment

NPV = 909090.91 + 826446.28 + 751314.80 + 683013.46 - 3000000

NPV = $ 169865.45 = $ 169865

For Project B

NPV = [400000 / (1 + 10%)^¹] + [900000 / (1 + 10%)^²] + [800000 / (1 + 10%)^³] - Initial Investment

NPV = 363636.36 + 743801.65  + 601051.84 - 1500000

NPV = $ 208489.86 = $ 208490

For Project C

NPV = [2000000 / (1 + 10%)^¹] + [2000000 / (1 + 10%)^²] + [200000 / (1 + 10%)^³] + [100000 / (1 + 10%)^⁴] - Initial Investment

NPV = 1818181.82 + 1652892.56 + 150262.96 + 68301.35 - 4000000

NPV = - $ 310361.31 = - $ 310361

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Requirement 3

The NPV method is generally regarded as the preferred method for project selection process, therefore the company should consider investing in the project with a Positive NPV (If only one project can be selected then select with highest NPV).

Since the company is limited by the total dollar value of capital investments (resources) it can make during the year, they should choose the investment with Highest Positive NPV.

Prior to making a final decision. The company should also consider the non financial qualitative factors of investment such as worker safety issues and customer satisfaction

Using only the NPV calculations from requirement 2, Andrew should invest in Project B