Question

 

Leeds Company has an opportunity to invest in one or two new projects. Project A requires a $350,000 investment for new machinery with a four-year life and no salvage value. Project B requires a $350,000 investment for new machinery with a three-year life and a $10,000 salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation and cash flows occur evenly throughout each year.

Project A

Sales	$350,000
Expenses:
Direct materials	49,000
Direct labor	70,000
Overhead including depreciation	126,000
Selling & administrative expenses	25,000
Tax rate	30%

Project B

Sales	$280,000
Expenses:
Direct materials	35,000
Direct labor	42,000
Overhead including depreciation	126,000
Selling & administrative expenses	25,000
Tax rate	30%

REQUIREMENTS:

1. In the first table in the working papers, you will use one column to determine net income, and the next column to determine net cash flows. HINT: Think about what on the income statement is never cash...this is the amount not to include in the net cash flows column. Compute each project’s annual expected net cash flows (round to nearest dollar)

2. Determine each project’s net present value using 8% as the discount rate (this is your interest rate). Assume that cash flows occur at each year-end (round to nearest dollar). Complete with both manual math formulas and using the Excel NPV formula.

3.   Determine each project’s payback period (round to two decimal places).

4.   Compute each project’s accounting rate of return (round percentage to one decimal place).

5.   Calculate using the Excel IRR tool, solving for the expected internal rate of return for each project.

6.   Explain to your instructor your investment recommendations, Project A or B? Be sure to use data arrived at in the above analysis.

Answer 1

Answer

1.

2.

NPV- Project A
Year	Project A	PVF @8%	Present Value
Initial Investment	(350,000.00)	1	(350,000.00)
Year 1	143,500.00	0.925925926	132,870.37
Year 2	143,500.00	0.85733882	123,028.12
Year 3	143,500.00	0.793832241	113,914.93
Year 4	143,500.00	0.735029853	105,476.78
NPV			125,290.20
NPV Project B
Year	Project A	PVF @8%	Present Value
Initial Investment	(350,000.00)	1	(350,000.00)
Year 1	149,733.33	0.925925926	138,641.98
Year 2	149,733.33	0.85733882	128,372.20
Year 3	149,733.33	0.793832241	118,863.15
Year 3 End	10,000.00	0.735029853	7,350.30
NPV			43,227.62

3.

Project A
Year	Cash Inflow	Cumulative Cash Flow
1	143,500.00	143,500.00
2	143,500.00	287,000.00
3	143,500.00	430,500.00
4	143,500.00	574,000.00
Project B
Year	Cash Inflow	Cumulative Cash Flow
1	149,733.33	149,733.33
2	149,733.33	299,466.67
3	159,733.33	459,200.00

Project A

We know that we will receive $350,000 between 2-3 year

So

Payback period = Confirmed Year + (Remaining Amount / That year cash flow)

= 2 Years + {(350,000 – 287,000) / 143,500}

Payback period = 2.44 Years

Project B

We know that we will receive $350,000 between 2-3 year

So

Payback period = Confirmed Year + (Remaining Amount / That year cash flow)

= 2 Years + {(350,000 – 299,466.67) / 159,733.33}

Payback period = 2.32 Years

4.

Project A

Average Investment = (Opening Investment Value + Closing Investment Value) / 2

Average Investment = $175,000 {(350,000 + 0) / 2}

ARR = {Net Income / Average Investment) * 100}

ARR = 32% {(56,000 / 175,000) * 100}

Project B

Average Investment = (Opening Investment Value + Closing Investment Value) / 2

Average Investment = $180,000 {(350,000 +10,00 0) / 2}

ARR = {Net Income / Average Investment) * 100}

ARR = 20.22% {(36,400 / 180,000) * 100}

5.

6.

We recommend Project A as it has Higher NPV and ARR but it has higher Payback period but we are still receiving the cash flow for that period which resulted in More NPV of Project A.