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.)

Make sure to view the PV table for this.

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

eTextbook and Media

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		$ _________		$ __________		$ _____________

eTextbook and Media

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 Bono		Project Edge		Project Clayton
Annual rate of return		_________ %		__________ %		_______________ %

eTextbook and Media

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 select a rank of the project  1 3  2		select a rank of the project select a rank of the project   2  3 1		select a rank of the project select a rank of the project   3  2 1
Edge		select a rank of the project select a rank of the project  1 3  2		select a rank of the project select a rank of the project  1 2  3		select a rank of the project select a rank of the project  1 2  3
Clayton		select a rank of the project select a rank of the project  1 3  2		select a rank of the project select a rank of the project  1 2  3		select a rank of the project select a rank of the project  1 2  3

The best project is select the best project select the best project  Edge,Clayton, or Bono?

Answer 1

Calculation of PBP:

Project bono
depreciation = 164800/5	32960
annual cash inflow = net income + depreciation	14420+32960	47380
PBP = initial investment /Annual cash inflow	164800/47380	3.48	years

Project Edge
Capital investment		180250
depreciation =	180250/5	36050
Year	net income	depreciation	cash flow	cumulative cash flow
1	18540	36050	54590	54590
2	17510	36050	53560	108150
3	16480	36050	52530	160680
4	12360	36050	48410	209090
5	9270	36050	45320	254410

PBP = 3+ ((180250-160680)/(209090-160680))

3.40

years

Project clayton
Capital investment		206000
depreciation =	206000/5	41200
year	net income	depreciation	cash flow	cumulative cash flow
1	27810	41200	69010	69010
2	23690	41200	64890	133900
3	21630	41200	62830	196730
4	13390	41200	54590	251320
5	12360	41200	53560	304880

PBP = 3+ ((206000-196730)/(251320-196730))

3.17

years

calculation of NPV:

					Present value
year	Project bono	Project Edge	Project clayton	PV factor at15%	Project bono	Project Edge	Project clayton
	a	b	c	d	a*d	b*d	c*d
0	-   164,800.00	-   180,250.00	-       206,000.00	1.00000	-         164,800	-        180,250	-             206,000
1	47,380.00	54,590.00	69,010.00	0.86957	41,200	47,470	60,009
2	47,380.00	53,560.00	64,890.00	0.75615	35,826	40,499	49,067
3	47,380.00	52,530.00	62,830.00	0.65752	31,153	34,540	41,312
4	47,380.00	48,410.00	54,590.00	0.57176	27,090	27,679	31,212
5	47,380.00	45,320.00	53,560.00	0.49718	23,556	22,532	26,629
				NPV	-              5,974	-             7,530	2,229

Annual rate of return = average net income/average capital investment	Project bono	Project Edge	Project clayton
total net income	72100	74160	98880
average net income = total net income/5	14420	14832	19776
average capital investment	82400	90125	103000
	(164800+0)/2	(180250+0)/2	(206000+0)/2
Annual rate of return	17.50%	16.46%	19.20%

Ranking
Project	PBP	NPV	ARR
Bono	3	2	2
edge	2	3	3
clayton	1	1	1

Hence The best project is Clayton