Exercise 172 Exercise 172 Savanna Company is considering two capital investment

Question

Exercise 172

Exercise 172

Savanna Company is considering two capital investment proposals. Relevant data on each project are as follows:
Project Red Project Blue Capital investment $440,000 640,000 Annual net income 25,000 60,000 Estimated useful life 8 years 8 years
Depreciation is computed by the straight-line method with no salvage value. Savanna requires an 8% rate of return on all new investments. The present value of 1 for 8 periods at 8% is .540 and the present value of an annuity of 1 for 8 periods is 5.747.

Explanation / Answer

Annual cash inflow Project Red 80000 =25000+(440000/8) Project Blue 140000 =60000+(640000/8) a Cash payback period Project Red 5.5 =440000/80000 Project Blue 4.6 =640000/140000 b Net present value Project Red 19760 =(80000*5.747)-440000 Project Blue 164580 =(140000*5.747)-640000 c Annual rate of return Project Red 11.4% =25000/(440000/2) Project Blue 18.8% =60000/(640000/2) Project Blue because it has a larger positive net present value and a higher annual rate of return

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