Question

Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $27,500. Each project will last for 3 years and produce the following net annual cash flows.

Year		AA		BB		CC
1		$8,750		$12,500		$16,250
2		11,250		12,500		15,000
3		15,000		12,500		13,750
Total		$35,000		$37,500		$45,000

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 PV table.

(a)

Compute each project’s payback period. (Round answers to 2 decimal places, e.g. 15.25.)

AA		?	years
BB		?	years
CC		?	years

Which is the most desirable project?

The most desirable project based on payback period is

?

Which is the least desirable project?

The least desirable project based on payback period is

?

(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		?
BB		?
CC		?

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

The most desirable project based on net present value is ?

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

The least desirable project based on net present value is ?

Answer 1

Solution a:

Computation of Cumulative Cash flows
Period	AA		BB		CC
	Cash inflows	Cumulative Cash Inflows	Cash inflows	Cumulative Cash Inflows	Cash inflows	Cumulative Cash Inflows
1	$8,750.00	$8,750.00	$12,500.00	$12,500.00	$16,250.00	$16,250.00
2	$11,250.00	$20,000.00	$12,500.00	$25,000.00	$15,000.00	$31,250.00
3	$15,000.00	$35,000.00	$12,500.00	$37,500.00	$13,750.00	$45,000.00

AA = 2 years + ($27500- $20000) / $15000 = 2.50 years

BB = 2 years + ($27500- $25000) / $12500 = 2.20 years

CC = 1 years + ($27500- $16250) / $15000 = 1.75 years

Most Desirable Project = Project CC

Least Desirable Project = Project AA

Solution b:

Computation of NPV - Doug Custom
			Project AA		Project BB		Project CC
Particulars	Period	PV Factor	Amount	Present Value	Amount	Present Value	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$27,500	$27,500	$27,500	$27,500	$27,500	$27,500
Present Value of Cash outflows (A)				$27,500		$27,500		$27,500
Cash Inflows
Year 1	1	0.89286	$8,750.00	$7,813	$12,500.00	$11,161	$16,250.00	$14,509
Year 2	2	0.79719	$11,250.00	$8,968	$12,500.00	$9,965	$15,000.00	$11,958
Year 3	3	0.71178	$15,000.00	$10,677	$12,500.00	$8,897	$13,750.00	$9,787
Present Value of Cash Inflows (B)				$27,458		$30,023		$36,254
Net Present Value (NPV) (B-A)				-$42		$2,523		$8,754

Most Desirable Project = Project CC

Least Desirable Project = Project AA