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Doug’s Custom Construction Company is considering three new projects, each requiring an equipment investment of $26,400. Each project will last for 3 years and produce the following net annual cash flows. Year AA BB CC 1 $8,400 $12,000 $15,600 2 10,800 12,000 14,400 3 14,400 12,000 13,200 Total $33,600 $36,000 $43,200 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. Click here to view PV of Annuity 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 Which is the least desirable project? The least desirable project based on payback period is (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 . Which is the least desirable project based on net present value? The least desirable project based on net present value is .
Expert Answer
Solution:
a) Calculation of the Each Project’s Payback Period:
AA:
| Year | Annual Net Cash Flow | Cumulative Net Cash Flow |
| 1 | $8,400 | $8,400 |
| 2 | $10,800 | $19,200 |
| 3 | $14,400 | $33,600 |
BB:
| Year | Annual Net Cash Flow | Cumulative Net Cash Flow |
| 1 | $12,000 | $12,000 |
| 2 | $12,000 | $24,000 |
| 3 | $12,000 | $36,000 |
CC:
| Year | Annual Net Cash Flow | Cumulative Net Cash Flow |
| 1 | $15,600 | $15,600 |
| 2 | $14,400 | $30,000 |
| 3 | $13,200 | $43,200 |
The Most Desirable Project based on Payback Period is Project CC, because it has Less Payback Period. The Lease Desirable Project based on Payback Period is Project AA, because it has Highest Payback Period.
b) Calculation of the Net Present Value of the Each Project:
| AA | BB | CC | |||||
| Year | Discount Factor | Net Annual Cash Flows | Present Value | Net Annual Cash Flows | Present Value | Net Annual Cash Flows | Present Value |
| 1 | 0.89286 | $8,400 | $7,500 | $12,000 | $10,714 | $15,600 | $13,929 |
| 2 | 0.79719 | $10,800 | $8,610 | $12,000 | $9,566 | $14,400 | $11,480 |
| 3 | 0.71178 | $14,400 | $10,250 | $12,000 | $8,541 | $13,200 | $9,395 |
| Total Present Value | $26,360 | $28,821 | $34,804 | ||||
| Investment | $26,400 | $26,400 | $26,400 | ||||
| NPV | $40 | $2,421 | $8,404 | ||||
The Most Desirable Project based on Net Present Value is Project CC. The Lease Desirable Project based on Net Present Value is Project AA. All Projects are Acceptable based on NPV.
