Exercise 26-9 Doug’s Custom Construction Company is considering three new projec

Question

Exercise 26-9

Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $26,620. Each project will last for 3 years and produce the following net annual cash flows.
Year AA BB CC 1 $8,470 $12,100 $15,730 2 10,890 12,100 14,520 3 14,520 12,100 13,310 Total $33,880 $36,300 $43,560
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.
Click here to view PV of Annuity 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 Project AAProject BBProject CC

Which is the least desirable project?
The least desirable project based on payback period is Project BBProject AAProject CC
(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 Project AAProject CCProject BB .
Which is the least desirable project based on net present value?
The least desirable project based on net present value is Project CCProject AAProject BB .

Explanation / Answer

a). Payback period of AA = 2 + 7260/ 14520 = 2.51 years

  Payback period of BB = 2 + 2420/ 12100 = 2.20 years

Payback period of CC = 1 + 3630/ 13310 = 1.27 years

the most desirable project is CC since its payback period is lowest and also lesser than 2 years as per the company's requirement.

the leaset desirable project is AA since it has the longest payback period.

b) NPV is calculated in the table below:

NPV of Project AA = -$41.01

NPV of Project BB = $2442.16

NPV of Project CC = $8473.69

The most desirable project based on net present value is Project CC

The least desirable project based on net present value is Project AA

Year Project AA Project BB Project CC PV Factor @ 12% PV of Project AA PV of Project BB PV of Project CC 0 -26620 -26620 -26620 1 -26620 -26620 -26620 1 8470 12100 15730 0.8929 7562.50 10803.57 14044.64 2 10890 12100 14520 0.7972 8681.44 9646.05 11575.26 3 14520 12100 13310 0.7118 10335.05 8612.54 9473.80 NPV -41.01 2442.16 8473.69

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