(TCO 6) Davis Company is considering two capital investment proposals. Estimates

Question

(TCO 6) Davis Company is considering two capital investment proposals. Estimates regarding each project are provided below.

Project A

Project B

Initial Investment

$800,000

$650,000

Annual Net Income

$50,000

45,000

Annual Cash Inflow

$220,000

$200,000

Salvage Value

$0

$0

Estimated Useful Life

5 years

4 years

The company requires a 10% rate of return on all new investments.

Part (a): Calculate the payback period for each project.
Part (b): Calculate the net present value for each project.
Part (c): Which project should Jackson Company accept and why? (Points : 30)

Project A

Project B

Initial Investment

$800,000

$650,000

Annual Net Income

$50,000

45,000

Annual Cash Inflow

$220,000

$200,000

Salvage Value

$0

$0

Estimated Useful Life

5 years

4 years

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part A: Payback Period

Payback Period = Initial Investment/Annual Cash Inflows:

Project A = 800000/220000 = 3.64 Years

Project B = 650000/200000 = 3.25 Years

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Part B: NPV

Project A = -800000 + 220000/(1+.10)^1 + 220000/(1+.10)^2 + 220000/(1+.10)^3 + 220000/(1+.10)^4 + 220000/(1+.10)^5 = $33973.09

Project B = -650000 + 200000/(1+.10)^1 + 200000/(1+.10)^2 + 200000/(1+.10)^3 + 200000/(1+.10)^4 = -$16026.91

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Part C:

Project A should be selected as it results in a + NPV.

Thanks.

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