5. Consider the following data. The data will be used for the entire problem. On

Question

5. Consider the following data. The data will be used for the entire problem. Only move investment passes the capital rationing test, put that investment into the next model. i.e. if one of the investments doesn't pass the payback test, don't move it forward to ROR. rward the giable investments to the next capital rationing model. Meaning if the Deadwood Corporation is considering 5 different investments. Here is the data for the 5 investments: LxI.9 Investment Initial Investment Year 1 Year 2 car 3 Year 4 1250000 S130,000 $850,000 $2.,550,000 $850,000 $625,000 560,000 320,000 660.000$200,000 $524.000 $235,000 $660,000$200,000 $435,000 $198,000 370. $370,000 $295,000 $280,000 s0 SO $95,000 5660,000 $200,000 $240,000 $99,000$660,000 $200,000 Year 5 $175,000 $O SO $O $660,000 $660,000 Year 6 Salvage Value Discount Rate $90,000 SO SO 9.95% 65,000 $100,000 $100,000 10.65% 9.10% 11.45% 13.45% a. Describe the payback period. Include strengths and weaknesses. (4 points) b. Calculate the payback period of each investment. (20 points) c. Which investment are acceptable? Which is the best? Why? (4 points) d. Describe the AROR. Include strengths and weaknesses. (4 points) e. Calculate the AROR for each investment. (20 points) f. Which investment are acceptable? Which is the best? Why? (4 points) g. What is the NPV? Strengths and weaknesses? (4 points) h. Calculate the NPV for each remaining investment. (20 points) i. Consider the discount rate as the minimum rate of return for Deadwood Corp. Which is superior? Why? (4 points) j. Calculate the profitability index of each. (6 points each) k. Considering all 4 capital rationing models, which is the best and why? (10 points) redit: What is the largest possible number you can write using only 2 numbers - just 2 , no other mathematical symbols?

Explanation / Answer

Deadwood Corporation a) Payback period represents the time needed for complete recovery of the initial investment in the project. Strengths 1 simplicity and easy to operate 2 clarifies the surplus concept i.e. no surplus unless payaback period is over 3 project having shorter payback period is preferred because funds can be rotated more number of times where risk of technologocal obsolesence is high risk and uncertainty increases with longer payback period promotes liquidity with earlier cash flows Weaknesses 1 Stresses on Capital Recovery rather than profits 2 does not consider post payback cash flows 3 ignores time value of money 4 gives incorrect results when cash flows are uneven Calculation of payback period of each Investment Investment Lk6 GtC99 Og33X GT11 LxI9 Initial Investment 1250000 1350000 850000 2550000 850000 Year Cumulative Cash flows Cumulative Cash flows Cumulative Cash flows Cumulative Cash flows Cumulative Cash flows 1 625000 625000 560000 560000 320000 320000 660000 660000 200000 200000 2 370000 995000 524000 1084000 235000 555000 660000 1320000 200000 400000 3 295000 1290000 435000 1519000 198000 753000 660000 1980000 200000 600000 4 280000 1570000 240000 1759000 99000 852000 660000 2640000 200000 800000 5 0 175000 1934000 0 660000 3300000 0 6 0 90000 2024000 0 660000 3960000 0 Payback Period 2 Years & 10.37Months 2 Years & 7.34 Months 3 Years & 11.76 Months 3 Years & 10.36 Months Does not recover the cost Payback Period is computed when cumulative cash flow equals initial Investments on time proportionate basis c) Investment with shorter Payabck period is accepted so GTC 99 which has payback period of 2 years and 7.34 months is the best. d) AROR method AROR means average annual yield on the project. It is also known as Accounting rate of return. Strengths 1 Simplicity 2 Easy to operate 3 Income throughout the project life is considered Weaknesses 1 Take rough average profits. Patterns or fluctuations in profit is ignored 2 It ignores time value of money Due to Policy of Chegg, I will not be able to answer more than four sub-parts of questions Thank You

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