Question

PRODILI Swifty 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 $171,200 $187,250 $202,000 Annual net income: Year 1 14,980 19,260 28,890 2 14,980 18,190 24,610 3 14,980 17,120 22,470 4 14,980 12,840 13,910 5 14,980 9,630 12,840 Total $74,900 $77,040 $102,720 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.) Click here to view PV table. 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

The depreciation expense is a non-cash expenditure which should be added to get the net cash flow.
The method used here is straight line depreciation and life is 5 years.

Project Bono
Depreciation Expense = (Initial Investment - Salvage Value) / Useful Life
171200 / 5 = 34240
Annual Cash Flow = 34240 + 14980 = 49220

Cumulative Cash Flow
Year 0 = -171200
Year1 = (14980 + 34240) - 171200 = -121980
Year 2 = -121980 + 49220 = -72760

We can create a table for all these values

Year		Bono		Edge		Clayton
	Cash Flow	Cumulative	Cash Flow	Cumulative	Cash Flow	Cumulative
0	-171200	-171200.00	-187250	-187250	-202000	-202000
1	49220	-121980.00	56710	-130540	69290	-132710
2	49220	-72760.00	55640	-74900	65010	-67700
3	49220	-23540.00	54570	-20330	62870	-4830
4	49220	25680.00	50290	29960	54310	49480
5	49220	74900.00	47080	77040	53240	102720
Payback		3.48		3.40		3.09

The cash flow for Bono has turned positive in the 4th year.
Payback Period = 3 + (23540 / (23540 + 25680)) = 3.48

b) Present worth can be calculated using following formula
PW = Cash Flow / (1+Interest Rate) ^ Duration

Let's consider Project Edge

PW Year 1
-187250 / (1.15 ^ 0) = -187250
Year 2
56710 / (1.15 ^ 1) = 49313.04
Year 3
55640 / (1.15 ^ 2) = 42071.83

We can again create a table

Year		Bono		Edge		Clayton
	Cash Flow	PW @ 15%	Cash Flow	PW @ 15%	Cash Flow	PW @ 15%
0	-171200	-171200.00	-187250	-187250.00	-202000	-202000
1	49220	42800.00	56710	49313.04	69290	60252.17
2	49220	37217.39	55640	42071.83	65010	49156.90
3	49220	32362.95	54570	35880.66	62870	41338.05
4	49220	28141.69	50290	28753.47	54310	31051.92
5	49220	24471.04	47080	23407.08	53240	26469.69
NPW		-6206.93		-7823.91		6268.727

c) Annual Rate of Return = ((Final Value / Initial Investment) ^ (1/Duration)) - 1

Project Bono
(164993.07 / 171200) ^ 0.2) - 1 = -0.74%

Project Edge
(179426.09 / 187250) ^ 0.2) -1 = -0.85%

Project Clayton
(208268.73 / 202000) ^ 0.2) -1 = 0.61%