Doug’s Custom Construction Company is considering three new projects, each requi
ID: 2487015 • Letter: D
Question
Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $19,570. Each project will last for 3 years and produce the following net annual cash flows.
Year AA BB CC
1 $8,343 $10,867 $13,493
2 10,712 10,867 10,403
3 15,553 10,867 11,433
Total $34,608 $32,601 $35,329
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%.
Compute each project’s payback period. (Round answers to 2 decimal places, e.g. 15.25.)
Which is the most desirable project?
Explanation / Answer
Project Pay Back period
AA :
year cash inflow Cumulative cash inflow
1 8343 8343
2 10712 19055
3 15553 34608
Pay Back period = 2 years + (19570 - 19055) / 15553
= 2years + 0.03
= 2.0 years
BB :
Pay back period = intial outflow / annual inflow
= 19570 / 10867
= 1.8 years
CC :
year cash inflow Cumulative cash inflow
1 13493 13493
2 10403 23896
3 11433 35329
Pay Back period = 1 year + 6077/10403
= 1 year + 0.58
= 1.6 year
CC is the most desirable project with a minimum year of time to recover the initial cost of the project.
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