Doug’s Custom Construction Company is considering three new projects, each requi
ID: 2475934 • Letter: D
Question
Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $24,860. Each project will last for 3 years and produce the following net annual cash flows.
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.)
Which is the most desirable project?
Which is the least desirable project?
(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.)
Which is the most desirable project based on net present value?
Which is the least desirable project based on net present value?
Explanation / Answer
Answer a. Project AA Project BB Project CC Year Net Cash Inflow Cummulative Cash Flow Net Cash Inflow Cummulative Cash Flow Net Cash Inflow Cummulative Cash Flow 1 7,910 7,910 11,300 11,300 14,690 14,690 2 10,170 18,080 11,300 22,600 13,560 28,250 3 13,560 31,640 11,300 33,900 12,430 40,680 Project AA Intial Investment = 24860 Project Payback Period = 2 years + (6780 / 13560) = 2.5 years Project BB Project Payback Period = 24860 / 11300 = 2.20 Years Project CC Project Payback Period = 1 years + (10170/ 13560) = 1.75 Years Most Desirable Project - Based on Payback period = Project CC - 1.75 Years Least Desirable Project - Based on Payback period = Project AA - 2.5 Years Answer b. Calculation of NPV of Equipment Project AA Particulars Year Amount 12% Factor Present value C D C X D Cash Inflow Net Cash Inflow 1 7,910 0.8929 7,063 2 10,170 0.7972 8,108 3 13,560 0.7118 9,652 A. Total Cash Inflow - PV 24,822 Cash Outflow Cost of Equipment 0 24,860 1.0000 24,860 B. Total Cash Outflow - PV 24,860 NPV (A - B) (38) Calculation of NPV of Equipment Project BB Particulars Year Amount 12% Factor Present value C D C X D Cash Inflow Net Cash Inflow 1 11,300 0.8929 10,090 2 11,300 0.7972 9,008 3 11,300 0.7118 8,043 A. Total Cash Inflow - PV 27,141 Cash Outflow Cost of Equipment 0 24,860 1.0000 24,860 B. Total Cash Outflow - PV 24,860 NPV (A - B) 2,281 Calculation of NPV of Equipment Project CC Particulars Year Amount 12% Factor Present value C D C X D Cash Inflow Net Cash Inflow 1 14,690 0.8929 13,117 2 13,560 0.7972 10,810 3 12,430 0.7118 8,848 A. Total Cash Inflow - PV 32,774 Cash Outflow Cost of Equipment 0 24,860 1.0000 24,860 B. Total Cash Outflow - PV 24,860 NPV (A - B) 7,914 Most Desirable Project - Based on NPV = Project CC - $7914 Least Desirable Project - Based on NPV = Project AA - ($38)
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