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		$161,600		$176,750		$204,000
Annual net income:
Year  1		14,140		18,180		27,270
2		14,140		17,170		23,230
3		14,140		16,160		21,210
4		14,140		12,120		13,130
5		14,140		9,090		12,120
Total		$70,700		$72,720		$96,960

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.

Compute the net present value for each project. Compute the annual rate of return for each project. (Hint: Use average annual net income in your computation.) Rank the projects on each of the foregoing bases. Which project do you recommend?

Answer 1

Net present value
Depreciation = 161600/5 = 32320
project bono
year	cash inflow	pvf@15%	present value
1	46460	0.86957	40400
2	46460	0.75614	35130.2644
3	46460	0.65752	30548.3792
4	46460	0.57175	26563.505
5	46460	0.49718	23098.9828
	total		155741.1314
	investment		-161600
	net present value	-5858.8686
Project Edge
Depreciation = 176750/5 = 35350
year	cash inflow	pvf@15%	present value
1	53530	0.86957	46547.83
2	52520	0.75614	39712.47
3	51510	0.65752	33868.86
4	47470	0.57175	27140.97
5	44440	0.49718	22094.68
	total		169364.81
	investment		-176750
	net present value	-7385.19
project Clayton
depreciation = 204000/5 =40800
year	cash inflow	pvf@15%	present value
1	68070	0.86957	59191.30
2	64030	0.75614	48415.64
3	62010	0.65752	40772.82
4	53930	0.57175	30834.48
5	52920	0.49718	26310.77
	total		205525.01
	investment		-204000
	net present value	1525.01
Annual rate of return
project bono = 14140/(161600/2) = 17.5%
project edge = (72720/5)/(176750/2) = 16.46%
project clayton = (96960/5)/(204000/2) = 19.01%
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