Question

A Manufacturing Company is considering two new projects, each requiring an equipment investment of $22,000. Each project will last for 3 years and produce the following annual net cash inflows. Year BB CC 1 $ 10,000 $14,000 2 10,000 10,000 3 10,000 6,000 Total $30,000 $30,000 The equipment's salvage value is zero for each machine. Cepeda uses straight-line depreciation. Cepeda's minimum required rate of return is 12%. Instructions (a) Compute each project's payback period. (Round to two decimals.) (b) Compute the net present value of each project. And clearly indicate the most desirable project if you are using only this method. (Round to nearest dollar.)

Answer 1

Computation of Payback period and net present value of projects BB & CC as follow:

PROJECT BB					PROJECT CC
Year	Cash flow	Pv '@12	PV of cash inflow	Cummulative cash flow		Year	Cash flow	Pv '@12	PV of cash inflow	Cummulative cash flow
1	10000	0.909	9090	9090		1	14000	0.909	12726	12726
2	10000	0.826	8260	17350		2	10000	0.826	8260	20986
3	10000	0.751	7510	24860		3	6000	0.751	4506	25492
Present value of cash flow	24860			Present value of cash flow	25492
Less: Initial investment	22000			Less: Initial investment	22000
Net present value	2860			Net present value	3492
Payback period = 2 years +( (22000-17350)/7510))		Payback period = 2 years +( (22000-20986)/4506))
	=	2.62 years				=	2.23 years

By comparing these two project, we can say project CC is more desirable. Since its NPV $3492 is more than project BB NPV $2860.

Hence, project CC is the most desirable project.