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Problem 12-1A (Video) U3 Company is considering three long-term capital investment proposals. Each investment has a...

Problem 12-1A (Video)

U3 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 $168,000 $183,750 $202,000
Annual net income:
Year  1 14,700 18,900 28,350
        2 14,700 17,850 24,150
        3 14,700 16,800 22,050
        4 14,700 12,600 13,650
        5 14,700 9,450 12,600
Total $73,500 $75,600 $100,800


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

Compute the net present value for each project. (Round answers to 0 decimal places, e.g. 125. If the net present value is negative, use either a negative sign preceding the number eg -45 or parentheses eg (45). For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Project Bono Project Edge Project Clayton
Net present value $ $

Compute the annual rate of return for each project. (Hint: Use average annual net income in your computation.) (Round answers to 2 decimal places, e.g. 10.50%.)

Project Bono Project Edge Project Clayton
Annual rate of return % % %

Solutions

Expert Solution

Calculation of payback period
depreciation = 168000/5 = 33600
project bono
payback period = capital investment/cash inflow
payback period = 168000/(14700+33600) = 3.48 years
Project Edge  
depreciation = 183750/5 = 36750
Years annual net income (a) depreciation(b) cash flow(a)+(b) cumulative cash flow
1 18900 36750 55650 55650
2 17850 36750 54600 110250
3 16800 36750 53550 163800
4 12600 36750 49350 213150
5 9450 36750 46200 259350
payback period = (183750-163800)/(213150-163800) = 0.40
payback period = 3+0.40 = 3.40years
project Clayton
depreciation = 202000/5 = 40400
Years annual net income (a) depreciation(b) cash flow(a)+(b) cumulative cash flow
1 28350 40400 68750 68750
2 24150 40400 64550 133300
3 22050 40400 62450 195750
4 13650 40400 54050 249800
5 12600 40400 53000 302800
payback period = (202000-195750)/(249800-195750) = 0.12
payback period = 3years+0.12= 3.12years
Net present value
project bono
year cash inflow pvf@15% present value
1 48300 0.86957 42000
2 48300 0.75614 36521.562
3 48300 0.65752 31758.216
4 48300 0.57175 27615.525
5 48300 0.49718 24013.794
total 161909.097
investment -168000
net present value -6090.903
Project Edge  
year cash inflow pvf@15% present value
1 55650 0.86957 48391.30
2 54600 0.75614 41285.24
3 53550 0.65752 35210.20
4 49350 0.57175 28215.86
5 46200 0.49718 22969.72
total 176072.32
investment -183750
net present value -7677.68
project Clayton
year cash inflow pvf@15% present value
1 68750 0.86957 59782.61
2 64550 0.75614 48808.84
3 62450 0.65752 41062.12
4 54050 0.57175 30903.09
5 53000 0.49718 26350.54
total 206907.20
investment -202000
net present value 4907.20
Annual rate of return = average net profit/average investment
project bono = 14700/(168000/2) = 17.5%
project edge = (75600/5)/(183750/2) = 16.46%
project clayton = (100800/5)/(202000/2) = 19.20%

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