Savanna Company is considering two capital investment proposals. Relevant data o
ID: 2756218 • 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
Payback Period
Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows generated by the investment. It is one of the simplest investment appraisal techniques.
Payback period = Initial Investement / Cash Inflow per period
4 yrs and 3.73 yrs
($112650) and ($100240)
c) ARR = Avg Income / Avg Investment
Project Red = $50000/$400000 = 0.125 or 12.5 %
Project Blue = $80000 / $ 560000 = 0.1428 or 14.28 %
d)Project Blue shall be selected.
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