(TCO 6) Savanna Company is considering two capital investment proposals. Relevan
ID: 2415540 • Letter: #
Question
(TCO 6) Savanna Company is considering two capital investment proposals. Relevant data on each project are as follows.
Project Red
Project Blue
Capital investment
$400,000
$560,000
Annual net income
$50,000
$80,000
Annual cash flows
$100,000
$150,000
Estimated useful life
8 years
8 years
Savanna requires an 8% rate of return on all new investments.
Part (a): Compute the payback period for each project.
Part (b): Compute the net present value for each project.
Part (c): Compute the accounting rate of return for each project.
Part (d): Which project should Savanna select?
(Points : 30)
Project Red
Project Blue
Capital investment
$400,000
$560,000
Annual net income
$50,000
$80,000
Annual cash flows
$100,000
$150,000
Estimated useful life
8 years
8 years
Explanation / Answer
Particulars Project Red Project Blue Capital investment $400,000.00 $560,000.00 Annual net income( Assumed after depreciation) $50,000.00 $80,000.00 Annual cash flows $100,000.00 $150,000.00 Estimated useful life $8.00 $8.00 Payback period= 400000/100000 560000/150000 Payback period= 4 3.73 Return Rate 8% 8% Present value in excel= PV(8%,8,-100000) (8%,8,-150000) Present value= $574,663.89 $861,995.84 NPV( PV- capital investment)= $174,663.89 $301,995.84 Accounting rate of return= 50000/400000 80000/560000 Accounting rate of return= 12.50% 14.29% Project Blue is selected because of the following reason- 1. Payback period of Project Blue is 3.73 year is less than 4 year of project Red 2. NPV of project Blue( 301995.84 ) is greater than Project Red ( ( 174663.89) 3.Accounting rate of return is greater in Project Blue (14.29%) than project Red ( 12.50%)
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