Question

Question 6

Swifty 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		$164,800		$180,250		$204,000
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.)

Compute the cash payback period for each project. (Round answers to 2 decimal places, e.g. 10.50.)

Project Bono			years
Project Edge			years
Project Clayton			years

Answer 1

PROJECT BONO

Step 1: Computation of Annual Cash flow

Year	Computation	Cash Flow
1	($14,420+$32,960)	47,380
2	($14,420+$32,960)	47,380
3	($14,420+$32,960)	47,380
4	($14,420+$32,960)	47,380
5	($14,420+$32,960)	47,380

Step 2: Cash Payback period

Cash Payback period = Investment / Annual Cash flow

Cash Payback period = $164,800 / $47,380 = 3.48 years

Working Notes:

Depreciation expense per year = $164,800 / 5 years = $32,960

Depreciation expense is non cash expense. So, it shall be added to annual income to get annual cash flows.

PROJECT EDGE

Step 1: Computation of Annual Cash flow

Year	Computation	Cash Flow	Cumulative Cash flows
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

Step 2: Cash Payback period

Year       Cash Flow

   1           $48,410 ($209,090 - $160,680)

   ?           $19,570 ($180,250 - $160,680)

   = $19,570 / $48,410 = 0.40 years

Cash Payback period = 3 Years + 0.40 Years = 3.40 years

Working Notes:

Depreciation expense per year = $180,250 / 5 years = $36,050

Depreciation expense is non cash expense. So, it shall be added to annual income to get annual cash flows.

PROJECT CLAYTON

Step 1: Computation of Annual Cash flow

Year	Computation	Cash Flow	Cumulative Cash flows
1	($27,810+$40,800)	$68,610	$68,610
2	($23,690+$40,800)	$64,490	$133,100
3	($21,630+$40,800)	$62,430	$195,530
4	($13,390+$40,800)	$54,190	$249,720
5	($12,360+$40,800)	$53,160	$302,880

Step 2: Cash Payback period

Year       Cash Flow

   1           $54,190 ($249,720 - $195,530)

   ?           $8,470 ($204,000 - $195,530)

   = $8,470 / $54,190 = 0.16 years

Cash Payback period = 3 Years + 0.16 Years = 3.16 years

Working Notes:

Depreciation expense per year = $204,000 / 5 years = $40,800

Depreciation expense is non cash expense. So, it shall be added to annual income to get annual cash flows.

All the best...