Question

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.

		Project Bono		Project Edge		Project Clayton
Capital investment		$164,800		$180,250		$204,000
Annual net income:
Year  1		14,420		18,540		27,810
2		14,420		17,510		23,690
3		14,420		16,480		21,630
4		14,420		12,360		13,390
5		14,420		9,270		12,360
Total		$72,100		$74,160		$98,880

Depreciation is computed by the straight-line method with no salvage value. The company’s cost of capital is 15%. (Assume that cash flows occur evenly throughout the year.)

(a)

Compute the cash payback period for each project. (Round answers to 2 decimal places, e.g. 10.50.)

Project Bono			years
Project Edge			years
Project Clayton			years

Answer 1

Step 1 Straight Line Depreciation = (Cost - Salvage Value) useful life Particulars Project Bona Project Edge Cost (A) $1,64,800 $1,80,250 Salvage Value (B) $0 Useful Life (C) Depreciation [{(A) - (B)}/(C)] $32,960 $36,050 Project Clayton $2,04,000 $0 $0 $40,800 Step 2 Calculation of Net Cash Flows Project Bona Depreciation Particulars Net Income (A) (B) Year 1 Year 2 Year 3 Year 4 Year 5 Total $14,420 $14,420 $14,420 $14,420 $14,420 $72,100 $32,960 $32,960 $32,960 $32,960 $32,960 Net Cash Flows (A) + (B) $47,380 $47,380 $47,380 $47,380 $47,380 $2,36,900 Project Edge Net Income Depreciation Net Cash Flow (C) (D) (C) + (D) $18,540 $36,050 $54,590 $17,510 $36,050 $53,560 $16,480 $36,050 $52,530 $12,360 $36,050 $48,410 $9,270 $36,050 $45,320 $74,160 $2,54,410 Project Clayton Net Income Depreciation Net Cash Flows (E) (F) (E) + (F) $27,810 $40,800 $68,610 $23,690 $40,800 $64,490 $21,630 $40,800 $62,430 $13,390 $40,800 $54,190 $12,360 $40,800 $53,160 $98,880 $3,02,880 Ans 1 Cash Payback Period: It is the number of years required recover the initial investment. It is based on cash flows. Cash Payback period = full year until recovery+ (Uncovered cost at the beginning of the last year/cash flow for last year) Project Bona Project Edge Project Clayton Particulars Cumulative Net Cash Cumulative Net Cash Flows Cumulative | Net Cash Flows Balance Balance Flows Balance Year 0 ($1,64,800) ($1,64,800) ($1,80,250) ($1,80,250) ($2,04,000) ($2,04,000) Year 1 $47,380 ($1,17,420) $54,590 ($1,25,660) $68,610 ($1,35,390) Year 2 $47,380 ($70,040) $53,560 ($72,100) $64,490 ($70,900) Year 3 $47,380 ($22,660) $52,530 ($19,570) $62,430 ($8,470) Year 4 $47,380 $24,720 $48,410 $28,840 $54,190 $45,720 Year 5 $47,380 $72,100 $45,320 $74,160 $53,160 $98,880 Cash Payback Period (in Years) 3.48 3.40 3.16 [3+ ($22660/$47380] [3+($19570/$48410] (3 + ($8470/$54190]