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. I got all the answers by my computation for average rate of return Is wrong

		Project Bono		Project Edge		Project Clayton
Capital investment		$164,800		$180,250		$206,000
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.)

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

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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

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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		enter percentages rounded to 2 decimal places %		enter percentages rounded to 2 decimal places %		enter percentages rounded to 2 decimal places %

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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 ranking number                                                                      132		select a ranking number                                                                      231		select a ranking number                                                                      321
Edge		select a ranking number                                                                      132		select a ranking number                                                                      123		select a ranking number                                                                      123
Clayton		select a ranking number                                                                      132		select a ranking number                                                                      123		select a ranking number                                                                      123

The best project is select a project                                                                      ClaytonEdgeBono.

Answer 1

Answer:

1) Calculation of cash payback period:

Annual cash inflow = Annual net income + Depreciation expense

The depreciation on the three projects is to be provided on straight line basis. Hence for each project, depreciation expense will be distributed equally for each year completed of the whole life of the projects.

Annual depreciation = Total capital investment / Life of project (in years)

Depreciation on Project Bono = $164,800 / 5 years = $32,960

Depreciation on Project Edge = $180,250 / 5 years = $36,050

Depreciation on Project Clayton = $206,000 / 5 years = $41,200

Project Bono = Capital investment = $164,800

Annual cash inflow = Annual net income + Depreciation expense

Years	Annual net income	Depreciation	Annual cash inflow	Cumulative cash flow
1	$14,420	$32,960	$47,380	$47,380
2	$14,420	$32,960	$47,380	$94,760
3	$14,420	$32,960	$47,380	$142,140
4	$14,420	$32,960	$47,380	$189,520
5	$14,420	$32,960	$47,380	$236,900

Cash payback period = 3 years + ($22,660 / $47,380)

                                = 3.48 years

Project Edge = Capital investment = $180,250

Years	Annual net income	Depreciation	Annual cash inflow	Cumulative cash flow
1	$18,540	$36,050	$54,590	$54,590
2	$17,510	$36,050	$53,560	$108,150
3	$16,480	$36,050	$52,530	$160,680
4	$12,360	$36,050	$48,410	$209,090
5	$9,270	$36,050	$45,320	$254,410

Cash payback period = 3 Years + ($19,570 / $48,410)

                                = 3.40 years

Project Clayton = Capital investment = $206,000

Years	Annual net income	Depreciation	Annual cash inflow	Cumulative cash flow
1	$27,810	$41,200	$69,010	$69,010
2	$23,690	$41,200	$64,890	$133,900
3	$21,630	$41,200	$62,830	$196,730
4	$13,390	$41,200	$54,590	$251,320
5	$12,360	$41,200	$53,560	$304,880

Cash payback period = 3 Years + ($9,270 / $54,590)

                                = 3.17 years

2. Net present value of each project:

Project Bono

Years	Annual cash inflow (i)	Present value factor @ 15% (ii)	Present value= (i) x (ii)
1	$47,380	0.869	$41,173.22
2	$47,380	0.756	$35,819.28
3	$47,380	0.657	$31,128.66
4	$47,380	0.571	$27,053.98
5	$47,380	0.496	$23,500.48
		Present value of cash inflows	$158,675.62
		Less: Capital investment	($164,800)
		Net present value	($6,124.38)

Net present value of Project Bono = ($6,124)

Project Edge

Years	Annual cash inflow (i)	Present value factor @ 15% (ii)	Present value= (i) x (ii)
1	$54,590	0.869	$47,438.71
2	$53,560	0.756	$40,491.36
3	$52,530	0.657	$34,512.21
4	$48,410	0.571	$27,642.11
5	$36,050	0.496	$17,880.80
		Present value of cash inflows	$167,965.19
		Less: Capital investment	($180,250)
		Net present value	($12,284.81)

Net present value of Project Edge = ($12,285)

Project Clayton

Years	Annual cash inflow (i)	Present value factor @ 15% (ii)	Present value= (i) x (ii)
1	$69,010	0.869	$59,969.69
2	$64,890	0.756	$49,056.84
3	$62,830	0.657	$41,279.31
4	$54,590	0.571	$31,170.89
5	$53,560	0.496	$26,565.76
		Present value of cash inflows	$208,042.49
		Less: Capital investment	($206,000)
		Net present value	$2,042.49

Net present value of Project Clayton = $2,042

3. Annual rate of return = (Average annual net income / Initial Investment) x 100

{Here, average annual net income = Total Net income / Number of years)

	Project Bono	Project Edge	Project Clayton
Total net income (Given)	$72,100	$74,160	$98,880
Number of years	5 years	5 years	5 years
Average net income	$72,100 / 5 years = $14,420	$74,160 / 5 years = $14,832	$98,880 / 5 years = $19,776
Initial investment	$164,800	$180,250	$206,000
Average rate of return	($14,420 / $164,800) x 100 = 8.75%	($14,832 / $180,250) x 100 = 8.23%	($19,776 / $206,000) x 100 = 9.60%

4. Project ranking table and recommendation:

		Ranking table
	Cash Payback Period	Net present value	Annual rate of return
Project Bono	3	2	2
Project Edge	2	3	3
Project Clayton	1	1	1

Out of the three projects, Project Clayton should be selected as this project has got the best ranking in all the three methods.

Years Annual income Depreciation $14,420 $14,420 $14,420 41 $14,420 5 $14,420 $32,960 $32,960 $32,960 $32,960 $32,960 Annual cash inflow $47,380 $47,380 $47,380 $47,380 $47,380 Cumulative cash flow $47,380 $94,760 $142, 140 $189,520 $236,900

Years Annual income Depreciation 11 $18,540 21 $17,510 $16,480 4. $12,360 5 $9,270 $36,050 $36,050 $36,050 $36,050 $36,050 Annual cash inflow $54,590 $53,560 $52,530 $48,410 $45,320 Cumulative cash flow $54,590 $108,150 $160,680 $209,090 $254,410

Years Annual income Depreciation $27,810 $41,200 21 $23,690 $41,200 $21,630 $41,200 $13,390 $41,200 $12,360 $41,200 Annual cash inflow $69,010 $64,890 $62,830 $54,590 $53,560 Cumulative cash flow $69,010 $133,900 $196,730 $251,320 $304,880

Years Annual cash inflow (i) Present value factor @ 15% (ii) Present value= (i) x (ii) $47,380 0.869 $41,173.22 $47,380 0.756 $35,819.28 $47,380 0.657 $31,128.66 $47,380 0.571 $27,053.98 5 $47,380 0.496 $23,500.48 Present value of cash inflows $158,675.62 Less: Capital investment ($164,800) Net present value ($6,124.38)

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Years Annual cash inflow Present value factor @ 15% (ii) Present value= (i) x (ii) $69,010 0.869 $59,969.69 $64,890 0.756|| $49,056.84 $62,830 0.657 $41,279.31 $54,590 0.571 $31,170.89 5 $53,560 0.496 $26,565.76 Present value of cash inflows $208,042.49 Less: Capital investment ($206,000) Net present value $2,042.49

Years Annual cash inflow (i) Present value factor @ 15% (ii) Present value= (i) x (ii) $47,380 0.869 $41,173.22 $47,380 0.756 $35,819.28 $47,380 0.657 $31,128.66 $47,380 0.571 $27,053.98 5 $47,380 0.496 $23,500.48 Present value of cash inflows $158,675.62 Less: Capital investment ($164,800) Net present value ($6,124.38)

Years Annual cash inflow $54,590 $53,560 $52,530 $48,410 5 $36,050 Present value factor @ 15% (ii) Present value= (i) x (ii) 0.869 $47,438.71 0.756|| $40,491.36 0.657 $34,512.21 0.571 $27,642.11 0.496 $17,880.80 Present value of cash inflows $167,965.19 Less: Capital investment ($180,250) Net present value ($12,284.81)

Years Annual cash inflow Present value factor @ 15% (ii) Present value= (i) x (ii) $69,010 0.869 $59,969.69 $64,890 0.756|| $49,056.84 $62,830 0.657 $41,279.31 $54,590 0.571 $31,170.89 5 $53,560 0.496 $26,565.76 Present value of cash inflows $208,042.49 Less: Capital investment ($206,000) Net present value $2,042.49

Years Annual cash inflow (i) Present value factor @ 15% (ii) Present value= (i) x (ii) $47,380 0.869 $41,173.22 $47,380 0.756 $35,819.28 $47,380 0.657 $31,128.66 $47,380 0.571 $27,053.98 5 $47,380 0.496 $23,500.48 Present value of cash inflows $158,675.62 Less: Capital investment ($164,800) Net present value ($6,124.38)

Years Annual cash inflow $54,590 $53,560 $52,530 $48,410 5 $36,050 Present value factor @ 15% (ii) Present value= (i) x (ii) 0.869 $47,438.71 0.756|| $40,491.36 0.657 $34,512.21 0.571 $27,642.11 0.496 $17,880.80 Present value of cash inflows $167,965.19 Less: Capital investment ($180,250) Net present value ($12,284.81)

Years Annual cash inflow Present value factor @ 15% (ii) Present value= (i) x (ii) $69,010 0.869 $59,969.69 $64,890 0.756|| $49,056.84 $62,830 0.657 $41,279.31 $54,590 0.571 $31,170.89 5 $53,560 0.496 $26,565.76 Present value of cash inflows $208,042.49 Less: Capital investment ($206,000) Net present value $2,042.49

Years Annual cash inflow (i) Present value factor @ 15% (ii) Present value= (i) x (ii) $47,380 0.869 $41,173.22 $47,380 0.756 $35,819.28 $47,380 0.657 $31,128.66 $47,380 0.571 $27,053.98 5 $47,380 0.496 $23,500.48 Present value of cash inflows $158,675.62 Less: Capital investment ($164,800) Net present value ($6,124.38)

Years Annual cash inflow $54,590 $53,560 $52,530 $48,410 5 $36,050 Present value factor @ 15% (ii) Present value= (i) x (ii) 0.869 $47,438.71 0.756|| $40,491.36 0.657 $34,512.21 0.571 $27,642.11 0.496 $17,880.80 Present value of cash inflows $167,965.19 Less: Capital investment ($180,250) Net present value ($12,284.81)

Years Annual cash inflow Present value factor @ 15% (ii) Present value= (i) x (ii) $69,010 0.869 $59,969.69 $64,890 0.756|| $49,056.84 $62,830 0.657 $41,279.31 $54,590 0.571 $31,170.89 5 $53,560 0.496 $26,565.76 Present value of cash inflows $208,042.49 Less: Capital investment ($206,000) Net present value $2,042.49