Question

Problem 12-1A 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 $171,200 $187,250 $206,000 Annual net income: Year 1 14,980 19,260 28,890 2 14,980 18,190 24,610 3 14,980 17,120 22,470 4 14,980 12,840 13,910 5 14,980 9,630 12,840 Total $74,900 $77,040 $102,720 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 % % % Rank the projects on each of the foregoing bases. Which project do you recommend? Project Cash Payback Net Present Value Annual Rate of Return Bono Edge Clayton The best project is .

Answer 1

Ans-Payback period- Project Bono

Depreciation per year 171,200/5 =$34,240

Cash payback period= 171,200/ (14,980+34,240)

= 3.48 years

Project Edge:- Depreciation per year= 187,250/ 5 = $37,450 per year

Year	Annual Net Income	Depreciation Value	Cumulative Cash Flow
1	19,260	37,450	56,710
2	18,190	37,450	112,350
3	17,120	37,450	166,920
4	12,840	37,450	217,210
5	9,630	37,450	264,290
	77,040

187,250-166,920= 20,330

20,330/(37,450+12,480)=0.41

Payback period = 3.41 years

Project Clayton:- Depreciation per year= 202,000/5- 40,400 per year

Year	Annual Net Income	Depreciation Value	Cumulative Cash Flow
1	28,890	40,400	69,290
2	24,610	40,400	134,300
3	22,470	40,400	197,170
4	13,910	40,400	251,480
5	12,840	40,400	304,720
	102,720

202,000-197,170= 4,830

4,830/ (40,400+13,910)=0.09

Payback period= 3.09 years

Ans-b- Calculation of NPV:-

	Project Bono			Project Edge		Project Clayton
Year	Discount Factor	Cash Inflow	PV	Cash Inflow	PV	Cash Inflow	PV
1	0.86957	49,220	42,800.24	56,710	49,313.32	69,290	60,252.51
2	0.75614	49,220	37,217.21	55,640	42,071.63	65,010	49,156.66
3	0.65752	49,220	32,363.13	54,570	35,880.87	62,870	41,338.28
4	0.57175	49,220	28,141.54	50,290	28,753.31	54,310	31,051.74
5	0.49718	49,220	24,471.20	47,080	23,407.23	53,240	26,469.86
	Total	246,100	164,993.32	264,290	179,426.35	304,720	208,269.06
	Investment		171,200		187,250		202,000
	NPV		-6,206.68		-7,823.65		6,269.04

Ans-c- Annual rate of return:-

Project BONO:-

=14,980/ (171,200+0)/2= 17.50%

Project EDGE:-

=(77,040/5)/ (187,250+0)/2 = 16.46%

Project Clayton:-

=(102,720/5)/ (202,000+0)/2 = 20.34%

Ans-d-Ranking

Project	Cash Payback	NPV	ARR
BONO	3	2	2
EDGE	2	3	3
CLAYTON	1	1	1