Savanna Company is considering two capital investment proposals. Relevant data o
ID: 2632207 • Letter: S
Question
Savanna Company is considering two capital investment proposals. Relevant data on each project are as follows.
Project Red
Project Blue
Capital investment
$400,000
$560,000
Annual net income
$50,000
$80,000
Annual cash flows
$100,000
$150,000
Estimated useful life
8 years
8 years
Savanna requires an 8% rate of return on all new investments.
Part (a): Compute the payback period for each project.
Part (b): Compute the net present value for each project.
Part (c): Compute the accounting rate of return for each project.
Part (d): Which project should Savanna select?
Project Red
Project Blue
Capital investment
$400,000
$560,000
Annual net income
$50,000
$80,000
Annual cash flows
$100,000
$150,000
Estimated useful life
8 years
8 years
Explanation / Answer
a)
payback period of project Red
= 400000/100000
= 4 years
payback period of project Blue
= 560000/150000
= 3.73 years
b)
NPV of red
= - 400000 + 100000 * [1-(1+0.08)^-8]/0.08
= -400000 + 574663.89
= 174663.89
NPV of blue
= - 560000 + 150000 * [1-(1+0.08)^-8]/0.08
= -560000 + 861995.84
= 301995.84
c)
annual rate of return of red
= 50000/(400000+0)/2
= 25%
annual rate of return of blue
= 80000/(560000+0)/2
= 28.57%
d)
Savanna should select project BLue
since it has higher NPV , hight rate of return
and less payback period
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