Doug’s Custom Construction Company is considering three new projects, each requi

Question

Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $22,000. Each project will last for 3 years and produce the following net annual cash flows.
Year AA BB CC 1 $7,000 $10,000 $13,000 2 9,000 10,000 12,000 3 12,000 10,000 11,000 Total $28,000 $30,000 $36,000
The equipment’s salvage value is zero, and Doug uses straight-line depreciation. Doug will not accept any project with a cash payback period over 2 years. Doug’s required rate of return is 12%. Click here to view PV table.

(a)

Compute each project’s payback period. (Round answers to 2 decimal places, e.g. 15.25.)
AA

years BB

years CC

years

Which is the most desirable project?
The most desirable project based on payback period is

Project AAProject BBProject CC

Which is the least desirable project?
The least desirable project based on payback period is

Project BBProject AAProject CC

(b)

Compute the net present value of each project. (Enter negative amounts using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45). Round final answers to the nearest whole dollar, e.g. 5,275. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)
AA

BB

CC

Which is the most desirable project based on net present value?
The most desirable project based on net present value is

Project CCProject BBProject AA

.
Which is the least desirable project based on net present value?
The least desirable project based on net present value is

Project AAProject BBProject CC

Explanation / Answer

Payback period = A + B/C

Where,
A = Last period with a negative cumulative cash flow;
B = Absolute value of cash flow at the end of the period A;
C = cash flow during the period after A.

a.

Project AA:

Payback period = 2 + 6000/12000 = 2.5 years

Project BB:

Payback period = 2 + 2000/10000 = 2.2 years

Project CC:

Payback period = 1 + 9000/12000 = 1.75 years

b. Most desirable project is Project CC. since the payback period is the least.

c. Least desirable project is Project AA. since the payback period is the highest.

B.

NPV is calculated by discounting the cashflows

PV = C/(1+r)^n

C - Cashflow

r - Discount rate

n - years to the cashflow

Project AA:

NPV = -$34

Project BB:

NPV = $2018

Project CC:

NPV = $7003.05

Most desirable project is project CC, since NPV is the highest.

Least desirable project is project AA, since NPV is the least.

Year Cashflow (A) Cumulative 0 -22000.00 -22000.00 1 7000.00 -15000.00 2 9000.00 -6000.00 3 12000.00 6000.00

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