U3 Company is considering three long-term capital investment proposals. Each inv

Question

U3 Company is considering three long-term capital investment proposals. Each investment has a useful life of 5 years. Relevant data on each project are as follows.

Depreciation is computed by the straight-line method with no salvage value. The company’s cost of capital is 15%. (Assume that cash flows occur evenly throughout the year.)

Project Bono Project Edge Project Clayton Capital investment $174,400 $190,750 $214,000 Annual net income: Year  1 15,260 19,620 29,430         2 15,260 18,530 25,070         3 15,260 17,440 22,890         4 15,260 13,080 14,170         5 15,260 9,810 13,080 Total $76,300 $78,480 $104,640 Compute the cash payback period for each project. (Round answers to 2 decimal places, e.g. 10.50.) Project Bono Project Edge Project Clayton years years years LINK TO TEXT LINK TO TEXT LINK TO TEXT VIDEO: SIMILAR PROBLEM Compute the net present value for each project. (Round answers to o decimal places, e.g. 125. If the net present value is negative, use either a negati sign preceding the number eg -45 or parentheses eg (45). For calculation purposes, use 5 decimal places as displayed in the factor table provided Project Bono Project Edge Project Clayton Net present value LINK TO TEXT LINK TO TEXTLINK TO TEXT VIDEO: SIMILAR PROBLEM Compute the annual rate of return for each project. (Hint: Use average annual net income in your computation.) (Round answers to 2 decimal places, e.g 10.50. Project Bono Project Edge Project Clayton Annual rate of return Wiley & Sons, Inc. Version

Explanation / Answer

Lets take each of the projects given in turn and calculate:

1. Project Bono:

Capital Investment = 174400

Net Income = 15260 per annum

The cash flows are even in this case:

Thus Payback Period = Capital Investment/Net Income = 174400/15260 = 11.43 years

Annual Rate of Return = Average net income/Total Investment

= 15260/174400 = .0875

Now Net Present Value or NPV = [r*(1-(1+i)^-n)/i] - Initial Investment

NPV = 15260(1-(1.0875)^-5/.0875) - 174400 = -114581

2. Project Edge:

Capital Investment = 190750

Payback period = Initial Investment/Cash flow per period = 190750/15696

= 12.15 years

Rate of return = Average income/Investment = 78480/190750*5 = .0823

NPV = [19620/1.0823+18530/1.0823^2+17440/1.0823^3+13080/1.0823^4+9810/1.0823^5]-190750

= [18128+15820+13732+9547.5+6606] - 190750 = - 126916.5

Project Clayton:

Payback Period = Investment/Average Income = 214000/20928 = 10.22 years

Rate of Return= Average Income/Investment = 104640/214000*5 = 0.0978

NPV = [29430/1.0978+25070/1.0978^2+22,890/1.0978^3+14,170/1.0978^4+13,080/1.0978^5] - 214000

= [26808.2+20804.97+17301.6+9756.3+8203.7] - 214000 = - 131125.23

Thus Project Bono is a better deal owing to lower payback time and lesser Net present Value in comparison.

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