CALCULATOR PRINTER VERSION BAC Exercise 16-2 Blue\'s Custom Constructlon Company

Question

CALCULATOR PRINTER VERSION BAC Exercise 16-2 Blue's Custom Constructlon Company Is consldering three new projects, each requiring an equipment investment of $22,440. Each project will last for 3 years and produce the following annual cash flows. Year AA 1 $7,140 $10,200 $13,260 9,180 10,200 12,240 12,240 10,200 11,220 Total $28,560 $30,600 $36,720 The equipment's salvage value is zero, and Blue uses straight-line depreciation. Blue will not accept any project with a cash payback period over 2 years. Blue's required rate of return is Compute each project's payback period. (Round answers to 2 decimal places, e.g. 15.25.) years years years Which is the most desirable project? The most desirable project based on payback period is Which is the least desirable project? The least desirable project based on payback perlod is

Explanation / Answer

Solution a):

Payback Period:

Project AA = 2+ (22440-16320)/12240 = 2.50 Years

Project BB = 2+ (22440-20400)/10200 = 2.20 years

Project CC = 1+ (22440- 13260)12240 = 1.75 years

The Most desirable project based on payback period = Project CC

The least desirable project based on payback period = Project AA

Solution b):

Since the required rate of of return is not visible in the question, therefore it is assumed that the required rate of return is 12% and threfore NPV is calculated at 12%.

From above table, the most desirable project based on NPV = Project CC

The Least desirable project based on NPV = Project AA

Computation of Cumulative Cash flows Period AA BB CC Cash inflows Cumulative Cash Inflows Cash inflows Cumulative Cash Inflows Cash inflows Cumulative Cash Inflows 1 $7,140.00 $7,140.00 $10,200.00 $10,200.00 $13,260.00 $13,260.00 2 $9,180.00 $16,320.00 $10,200.00 $20,400.00 $12,240.00 $25,500.00 3 $12,240.00 $28,560.00 $10,200.00 $30,600.00 $11,220.00 $36,720.00

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