Comparing, Prioritizing Multiple Projects
Allister Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them.
Project 1: Retooling Manufacturing Facility
This project would require an initial investment of $5 million. It would generate $750,000 in additional cash flow each year. The new machinery has a useful life of eight years and a salvage value of $500,000.
Project 2: Purchase Patent for New Product
The patent would cost $3,400,000, which would be fully amortized over five years. Production of this product would generate $1,200,000 additional annual net income for Allister.
Project 3: Purchase a New Fleet of Delivery Trucks
Allister could purchase 25 new delivery trucks at a cost of $75,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,000. Purchasing the fleet would allow Allister to expand its customer territory resulting in $500,000 of additional net income per year.
Required:
1.Determine each project’s accounting rate of return.
2.Determine each project’s payback period.
3.Using a discount rate of 10 percent, calculate the net present value of each project.
4.Determine the profitability index of each project and prioritize the projects for Allister.
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