Question

Carper Company is considering a capital investment of $390,000 in additional productive facilities. The new machinery is expected to have useful life of 6 years with no salvage value. Depreciation is by the straight-line method. During the life of the investment, annual net income and net annual cash flows are expected to be $20,000 and $85,000, respectively. Carper has an 8% cost of capital rate, which is the required rate of return on the investment.

Instructions (Round to two decimals.)

1. Compute (1) the cash payback period and (2) the annual rate of return on the proposed capital expenditure.
2. Using the discounted cash flow technique, compute the net present value.
3. Carper was presented with a second capital investment that provided similar production facilities as the first one. This investment cost $400,000, had a useful life of 7 years with a salvage value of $15,000. Depreciation is by the straight-line method. During the life of the investment, annual net income and net annual cash flows are expected to be $25,000 and $80,000 respectively. Carper’s 8% cost of capital is also the required rate of return on the investment.

1. Compute the cash payback period.
2. Compute the annual rate of return.
3. Using the discounted cash flow technique, compute the net present value.
4. Based on these calculations, which investment do you recommend? Explain why.

Answer 1

1 Calculation of Payback period of Project

Calculation of Payback period of Project
Year	Initial investment	Cashflows	cumilativ Cashflow	Balance
0	-390000		0
1		85000	85000	305000
2		85000	170000	220000
3		85000	255000	135000
4		85000	340000	50000
5		85000	425000	Balance	0.59
6		85000	510000
Payback period	4.59 Years

2) annual rate of Return

= 20000/390000 *100 = 5.12%

3) Calculation of NPV Of the Project

year	0	1	2	3	4	5	6
Net Cashflow	-390000	85000	85000	85000	85000	85000	85000
Discounting Factor	1	0.92593	0.85734	0.79383	0.73503	0.68058	0.63017
Present Value	-390000	78703.704	72873.8	67475.74	62477.54	57849.57	53564.42
NPV	2944.77

PROJECT

1 Projects Payback Period

Calculation of Payback period of Project
Year	Initial investment	Cashflows	cumilativ Cashflow	Balance
0	-400000		0
1		80000	80000	320000
2		80000	160000	240000
3		80000	240000	160000
4		80000	320000	80000
5		80000	400000	0
6		80000	480000
7		80000	560000
Payback period	4.00Years

2) ARR of the Project

25000/400000 *100

=6.25%

3) Calculation of NPV of the Project

Calculation of NPV of Machine
year	0	1	2	3	4	5	6	7
Net Cashflow	-400000	80000	80000	80000	80000	80000	80000	80000
Discounting Factor	1	0.92593	0.85734	0.79383	0.73503	0.68058	0.63017	0.58349
Present Value	-400000	74074.074	68587.11	63506.58	58802.39	54446.66	50413.57	46679.23
NPV	16509.60

Based on the Calculation 2nd Project will give More wealth to shareholders within a short period than 1st project. 2nd project will be more suitable for Carper company. As second projects ARR is bit higher than 1st project it also considered.