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 $174,400 $190,750 $218,000 Annual net income: Year 1 15,260 19,620 29,430 2 15,260 18,530 25,070 3 15,260 17,440 22,890 4 15,260 13,080 14,170 5 15,260 9,810 13,080 Total $76,300 $78,480 $104,640 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

Answer 1

To calculate cash payback period, firstly calculate the cash flow from project that in this case = Net Income + Annual Depreciation Charge. Because depreciation is a non-cash expense.

Annual Depreciation on Project Bono = 174,400 / 5 = 34,880

Annual Depreciation on Project Edge = 190,750 / 5 = 38,150

Annual Depreciation on Project Clayton = 218,000 / 5 = 43,600

Answer-1:

	Project Bono
Year	Net Income	Annual Depreciation	Cash Inflows
1	15260	34880	50140
2	15260	34880	50140
3	15260	34880	50140
4	15260	34880	50140
5	15260	34880	50140

Cash Payback Period = Total Investment / Annual Cash Inflow

                                      = 174,400 / 50,140

                                      = 3.478 years

Answer-2:

Project Edge
Year	Net Income	Annual Depreciation	Cash Inflows	Cumulative Cash Inflow
1	19620	38150	57770	57770
2	18530	38150	56680	114450
3	17440	38150	55590	170040
4	13080	38150	51230	221270
5	9810	38150	47960	269230

Cumulative cash flow shows that, total investment of $ 190,750 will be recovered in between 3 to 4 year, Cash Payback Period;

   = 3 years + (190,750 – 170,040)/51,230

= 3 years + 20710 / 51230

= 3 years + 0.404 year

= 3.404 years.

Answer-3:

Project Clayton
Year	Net Income	Annual Depreciation	Cash Inflows	Cumulative Cash Inflow
1	29430	43600	73030	73030
2	25070	43600	68670	141700
3	22890	43600	66490	208190
4	14170	43600	57770	265960
5	13080	43600	56680	322640

Cumulative cash flow shows that, total investment of $ 218,000 will be recovered in between 3 to 4 year, Cash Payback Period;

= 3 years + (218,000 – 208,190)/57,770

= 3 years + 9,810 / 57,770

= 3 years + 0.169 year

= 3.169 years

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