Question

Exercise 25-02

Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $24,420. Each project will last for 3 years and produce the following net annual cash flows.

Year		AA		BB		CC
1		$7,770		$11,100		$14,430
2		9,990		11,100		13,320
3		13,320		11,100		12,210
Total		$31,080		$33,300		$39,960

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		Enter a number of years rounded to 2 decimal places	years
BB		Enter a number of years rounded to 2 decimal places	years
CC		Enter a number of years rounded to 2 decimal places	years

Which is the most desirable project?

The most desirable project based on payback period is

select a project Project AAProject BBProject CC

Which is the least desirable project?

The least desirable project based on payback period is

select a project Project BBProject AAProject CC

(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		enter a dollar amount rounded to 0 decimal places
BB		enter a dollar amount rounded to 0 decimal places
CC		enter a dollar amount rounded to 0 decimal places

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

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

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 BBProject CCProject AA .

Answer 1

Answer a.

Project AA:

Company can recoup initial investment of $17,760 ($7,770 + $9,990) in first 2 years and remaining $6,660 in 3rd year

Payback Period = 2 + $6,660 / $13,320
Payback Period = 2.50 years

Project BB:

Company can recoup initial investment of $22,200 ($11,100 + $11,100) in first 2 years and remaining $2,220 in 3rd year

Payback Period = 2 + $2,220 / $11,100
Payback Period = 2.20 years

Project CC:

Company can recoup initial investment of $14,430 in first year and remaining $9,990 in 2nd year

Payback Period = 1 + $9,990 / $13,320
Payback Period = 1.75 years

Project CC is most desirable project.
Project AA is least desirable project.

Answer b.

Project AA:

Net Present Value = -$24,420 + $7,770 * PV of $1 (12%, 1) + $9,990 * PV of $1 (12%, 2) + $13,320 * PV of $1 (12%, 3)
Net Present Value = -$24,420 + $7,770 * 0.89286 + $9,990 * 0.79719 + $13,320 * 0.71178
Net Present Value = -$38

Project BB:

Net Present Value = -$24,420 + $11,100 * PV of $1 (12%, 1) + $11,100 * PV of $1 (12%, 2) + $11,100 * PV of $1 (12%, 3)
Net Present Value = -$24,420 + $11,100 * 0.89286 + $11,100 * 0.79719 + $11,100 * 0.71178
Net Present Value = $2,240

Project CC:

Net Present Value = -$24,420 + $14,430 * PV of $1 (12%, 1) + $13,320 * PV of $1 (12%, 2) + $12,210 * PV of $1 (12%, 3)
Net Present Value = -$24,420 + $14,430 * 0.89286 + $13,320 * 0.79719 + $12,210 * 0.71178
Net Present Value = $7,773

Project CC is most desirable project.
Project AA is least desirable project.