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		$163,200		$178,500		$204,000
Annual net income:
Year  1		14,280		18,360		27,540
2		14,280		17,340		23,460
3		14,280		16,320		21,420
4		14,280		12,240		13,260
5		14,280		9,180		12,240
Total		$71,400		$73,440		$97,920

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		enter the cash payback period in years for the project rounded to 2 decimal places	years
Project Edge		enter the cash payback period in years for the project rounded to 2 decimal places	years
Project Clayton		enter the cash payback period in years for the project rounded to 2 decimal places	years

Compute the net present value for each project. (Round answers to 0 decimal places, e.g. 125. If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

	Project Bono		Project Edge		Project Clayton
Net present value		$enter a dollar amount rounded to 0 decimal places		$enter a dollar amount rounded to 0 decimal places		$enter a dollar amount rounded to 0 decimal places

Compute the annual rate of return for each project. (Hint: Use average annual net income in your computation.) (Round answers to 2 decimal places, e.g. 10.50.)

Project BonoProject EdgeProject Clayton

Annual rate of return

enter a percentage number rounded to 2 decimal places

Rank the projects on each of the foregoing bases. Which project do you recommend?

Project		Cash Payback		Net Present Value		Annual Rate of Return
Bono		select a rank of the project                                                                      132		select a rank of the project                                                                      231		select a rank of the project                                                                      321
Edge		select a rank of the project                                                                      132		select a rank of the project                                                                      123		select a rank of the project                                                                      123
Clayton		select a rank of the project                                                                      132		select a rank of the project                                                                      123		select a rank of the project                                                                      123

The best project is select the best project                                                                      BonoEdgeClayton.

Please be as specific as possible, I am confused on how to properly calculate each cash flow. Thank you.

Answer 1

Calculation of payback period
depreciation = 163200/5 = 32640
project bono
payback period = capital investment/cash inflow
payback period = 163200/(14280+32640) = 3.48 years
Project Edge
depreciation = 178500/5 = 35700
Years	annual net income (a)	depreciation(b)	cash flow(a)+(b)	cumulative cash flow
1	18360	35700	54060	54060
2	17340	35700	53040	107100
3	16320	35700	52020	159120
4	12240	35700	47940	207060
5	9180	35700	44880	251940
payback period = (178500-159120)/(207060-159120) = 0.40
payback period = 3+0.40 = 3.40years
project Clayton
depreciation = 204000/5 = 40800
Years	annual net income (a)	depreciation(b)	cash flow(a)+(b)	cumulative cash flow
1	27540	40800	68340	68340
2	23460	40800	64260	132600
3	21420	40800	62220	194820
4	13260	40800	54060	248880
5	12240	40800	53040	301920
payback period = (204000-194820)/(248880-194820) = 0.17
payback period = 3years+0.16 = 3.17years
Net present value
project bono
year	cash inflow	pvf@15%	present value
1	46920	0.86957	40800
2	46920	0.75614	35478.0888
3	46920	0.65752	30850.8384
4	46920	0.57175	26826.51
5	46920	0.49718	23327.6856
	total		157283.1228
	investment		-163200
	net present value		-5916.8772
Project Edge
year	cash inflow	pvf@15%	present value
1	54060	0.86957	47008.70
2	53040	0.75614	40105.67
3	52020	0.65752	34204.19
4	47940	0.57175	27409.70
5	44880	0.49718	22313.44
	total		171041.69
	investment		-178500
	net present value		-7458.31
project Clayton
year	cash inflow	pvf@15%	present value
1	68340	0.86957	59426.09
2	64260	0.75614	48589.56
3	62220	0.65752	40910.89
4	54060	0.57175	30908.81
5	53040	0.49718	26370.43
	total		206205.77
	investment		-204000
	net present value		2205.77
Annual rate of return = average net profit/average investment
project bono = 14280/(163200/2) = 17.5%
project edge = (73440/5)/(178500/2) = 16.46%
project clayton = (97920/5)/(204000/2) = 19.20%
Rank
project	cash payback	net present value	annual rate of return
Bono	3	2	2
Edge	2	3	3
Clayton	1	1	1
the best project is Clayton