Question

Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $23,320. Each project will last for 3 years and produce the following net annual cash flows.

Year		AA		BB		CC
1		$7,420		$10,600		$13,780
2		9,540		10,600		12,720
3		12,720		10,600		11,660
Total		$29,680		$31,800		$38,160

The equipment’s salvage value is zero, and Doug uses straight-line depreciation. Doug will not accept any project with a cash payback period over 2 years. Doug’s required rate of return is 12%. Click here to view the factor table.

(a)

Compute each project’s payback period. (Round answers to 2 decimal places, e.g. 15.25.)

AA			years
BB			years
CC			years

Which is the most desirable project?

The most desirable project based on payback period is

select a project

Which is the least desirable project?

The least desirable project based on payback period is

select a project

(b)

Compute the net present value of each project. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45). Round final answers to the nearest whole dollar, e.g. 5,275. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

AA
BB
CC

Which is the most desirable project based on net present value?

The most desirable project based on net present value is select a project

Which is the least desirable project based on net present value?

The least desirable project based on net present value is select a project                                                          Project CCProject AAProject BB.

Answer 1

a.

Computation of Cumulative Cash flows
Period	AA	BB	CC
Cash inflows	Cumulative Cash Inflows	Cash inflows	Cumulative Cash Inflows	Cash inflows	Cumulative Cash Inflows
1	$7,420.00	$7,420.00	$10,600.00	$10,600.00	$13,780.00	$13,780.00
2	$9,540.00	$16,960.00	$10,600.00	$21,200.00	$12,720.00	$26,500.00
3	$12,720.00	$29,680.00	$10,600.00	$31,800.00	$11,660.00	$38,160.00

Payback period:

Project AA = 2 years + ($23320 - $16960) / $12,720 = 2.50 years

Project BB = $23,320 / $10,600 = 2.20 years

Project CC =  1 year + ($23320 - $13,780) / $12,720 = 1.75 years

Most desirable project based on payback period is "Project CC"

Least desirable project based on payback period is "Project AA"

b.

Computation of NPV - Doug Custom
			Project AA	Project BB	Project CC
Particulars	Period	PV Factor	Amount	Present Value	Amount	Present Value	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$23,320	$23,320	$23,320	$23,320	$23,320	$23,320
Present Value of Cash outflows (A)				$23,320		$23,320		$23,320
Cash Inflows
Year 1	1	0.89286	$7,420.00	$6,625	$10,600.00	$9,464	$13,780.00	$12,304
Year 2	2	0.79719	$9,540.00	$7,605	$10,600.00	$8,450	$12,720.00	$10,140
Year 3	3	0.71178	$12,720.00	$9,054	$10,600.00	$7,545	$11,660.00	$8,299
Present Value of Cash Inflows (B)				$23,284		$25,459		$30,743
Net Present Value (NPV) (B-A)				-$36		$2,139		$7,423

Most desirable project based on NPV is Project "CC" Least desirable project based on NPV is Project "AA"