Doug’s Custom Construction Company is considering three new projects, each requi

Question

Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $21,850. Each project will last for 3 years and produce the following net annual cash flows. Year AA BB CC 1 $9,315 $12,133 $15,065 2 11,960 12,133 11,615 3 17,365 12,133 12,765 Total $38,640 $36,399 $39,445 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%.

Explanation / Answer

Payback period :

AA = 2 + (575/16790)

      = 2+ .03 = 2.03 Years

BB = 1+ (9717 / 12133)

     = 1+ .80

      = 1.8 YEARS

CC= 1+ (6785 / 11615)

     = 1+ .58

      = 1.58 Years

**Period = year up to which cummulative cash flow is negative +(Cummulative cash flow of that year /cash flow of next year)

On the basis of thsProject AA shall be rejected as it has payback period of more than 2 years

year AA BB CC Cash flow cummulative cash flow cash flow cummulative cash flow cash flow cummulative cash flow 0 - 21850 -21850 -21850 -21850 -21850 -21850 1 9315 -12535     [-21850+9315] 12133 -9717 15065 -6785 2 11960 -575    [-12535+11960] 12133 2416 11615 4830 3 17365 16790 12133 12765

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