Most Company has an opportunity to invest in one of two new projects. Project Y

Question

Most Company has an opportunity to invest in one of two new projects. Project Y requires a $340,000 investment for new machinery with a five-year life and no salvage value. Project Z requires a $340,000 investment for new machinery with a four-year life and no salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation, and cash flows occur evenly throughout each year. (FV of $1, PV of $1, FVA of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Most Company has an opportunity to invest in one of two new projects. Project Y requires a $340,000 investment for new machinery with a five-year life and no salvage value. Project Z requires a $340,000 investment for new machinery with a four-year life and no salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation, and cash flows occur evenly throughout each year. (FV of $1, PV of $1, FVA of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

Explanation / Answer

For Project Y,

Initial investment = $340,000

Useful life = 5 years

Company is using straight line depreciation

So depreciation = 340,000/5 = $68,000

Net Income = $49,600

Cash flow = net income + depreciation = 49600 + 68000 = $117,600

Therefore Initial cash flow = - $340,000 (negative sign indicates cash outflow)

Annual cash flow i.e. cash flow from year 1 to 5 = $117,600

For Project Z,

Initial investment = $340,000

Useful life = 4 years

Company is using straight line depreciation

So depreciation = 340,000/4 = $85,000

Net Income = $32,240

Cash flow = net income + depreciation = 32240 + 85000 = $117,240

Therefore Initial cash flow = - $340,000 (negative sign indicates cash outflow)

Annual cash flow i.e. cash flow from year 1 to 4 = $117,240

Payback period is the time in which a project returns its investment

For project Y,

Payback period = Initial investment / Annual cash flow = 340,000 / 117,600 = 2.89 years

Therefore, in 2.89 years project is return its investment amount (We are assuming that within a year project is returning amount evenly)

For project Z,

Payback period = Initial investment / Annual cash flow = 340,000 / 117,240 = 2.90 years

Therefore, in 2.90 years project is return its investment amount (We are assuming that within a year project is returning amount evenly)

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