Halls Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year. The capital budget is limited to $12,000,000 for the year. Lydia Baker, staff analyst at Halls, is preparing an analysis of the three projects under consideration by Calvin Halls, the company's owner.
Requirements
1. Because the company's cash is limited, Halls 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 Halls choose?
2. Baker 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.
Homework Answers
1.b Payback for projects:-
Project A = 2050000 + 2050000 = 4100000 in 2 yrs
Required inflows = 6000000 - 4100000 = 1900000
Remaining inflow of 1900000 is earned in = 1900000/2050000 = 0.926 yrs
Total pay back for Project A is 2.926 yrs
Project B = 1100000 + 2300000 = 3400000 in 2 yrs
Required inflows = 4000000 - 3400000= 600000
Remaining inflows of 600000 is earned in = 600000/700000 = 0.857 yrs
Total payback for Project B is 2.857 yrs
Project C = 4700000 in 1st yr
Required inflows = 8000000 - 4700000 = 3300000
Remaining inflows of 3300000 is earned in = 3300000/4700000 = 0.702 yrs
Total payback for Project C is 1.702 yrs
Halls should choose Project C as the payback period is lowest i.e. 1.702 yrs.
2. Payback for projects:-
Project A = (2050000 /1.08)+ (2050000/1.08^2) + (2050000/1.08^3) + (2050000/1.08^4) = 1898148.148 + 1757544.582 + 1627356.094 + 1506811.198 = 6,789,860.022
Project B = (1100000/1.08) + (2300000/1.08^2) + (700000/1.08^3) = 1018518.519 + 1971879.287 + 555682.5687 = 3,546,080.375
Project C = (4700000 /1.08) + (4700000/1.08^2) + (50000/1.08^3) + (25000/1.08^4) = 4351851.852 + 4029492.455 + 39691.612 + 18375.746 = 8,439,411.665
3. I would recommend funding for Project C as it has the lowest payback period and has the highest NPV.
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Halls Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year
Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year....
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 Babson, staff analyst at
Halls, is preparing an analysis of the three projects under
consideration by Corey Halls, the company's owner.
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