Question Help E21-22 (similar to) Benson, staff analyst at Rzzis, is preparing a

Question

Question Help E21-22 (similar to) Benson, staff analyst at Rzzis, is preparing an analysis of the three projects under consideration by Chester Rozzis, the company's owner Rozzis Construction is analyzing its capital expenditure proposals for the purchase of equipment in the EE (Cick the icon to view the data for the three projects) year Linda Read the requirements the company's cash is limited, Rozzis thinks the payback method should be used to choose between the capital budgeting projects Requirement 1.Because a. What are the benefts and limitations of using the payback method to choose between projects? Benefits of the payback method A. Easy to understand and captures uncertainty about expected cash tows in later years of a projesct Indicates whether or not the project will earn the company's minimum required rate of return C Utices the time value of money and computes each projects unique rate of return All of the above Umitations of the payback method 0 A. Cannot be used when managements ' ??. Carnot be used for pruids with unegal required rate of reun varies trom one perniod to the next odic cash tows ais to incorporate the time value of money and does not consider a projects cash tows ator the payback period D. All of the above

Explanation / Answer

Requirement 1. a Benefits of the payback Period: Option A. Easy to understand and captures uncertainly about expected cash flows in later years of a project Limitations of the payback Period: Option C. Fails to Incorporate the time value of money and does not consider a project's cash flows after the payback period Requirement 1. b Payback Period (Project A) = (3000000/1200000) = 2.50 years Note: there is equal cash flows Payback Period (Project B) Year 0 Year 1 Year 2 Year 3 Expected Cash flow -2100000 1200000 600000 500000 Cumulative cash flow -2100000 -900000 -300000 200000 Payback Period = 2.60 Years = 2 +(300,000/500,000) = 2.60 Years Payback Period (Project C) Year 0 Year 1 Year 2 Year 3 Year 4 Expected Cash flow -3000000 1700000 1700000 200000 100000 Cumulative cash flow -3000000 -1300000 400000 600000 700000 Payback Period = 1.76 Years = 1 +(1,300,000/1,700,000) = 1.76 Years Project C should Rozzis choose as it is less pay back period Requirement 2 Net present value method (Project A) Year 0 Year 1 Year 2 Year 3 Year 4 Cash flow -3000000 1200000 1200000 1200000 1200000 PV factor of 1$ at 8% 1.00000 0.925926 0.857339 0.793832 0.735030 Discounted Cash flow -3000000 1111111 1028807 952598 882036 Cumulative cash flow -3000000 -1888889 -860082 92516 974552 NPV = $974,552 Net present value method (Project B) Year 0 Year 1 Year 2 Year 3 Cash flow -2100000 1200000 600000 500000 PV factor of 1$ at 8% 1.00000 0.925926 0.857339 0.793832 Discounted Cash flow -2100000 1111111 514403 396916 Cumulative cash flow -2100000 -988889 -474486 -77570 NPV = $-77,570 Net present value method (Project C) Year 0 Year 1 Year 2 Year 3 Year 4 Cash flow -3000000 1700000 1700000 200000 100000 PV factor of 1$ at 8% 1.00000 0.925926 0.857339 0.793832 0.735030 Discounted Cash flow -3000000 1574074 1457476 158766 73503 Cumulative cash flow -3000000 -1425926 31550 190316 263819 NPV = $263,819 Requirement 3 Project A , would be recommended funding Explanation: Project A has high NPV with equal initial investment of project C. Project B can not be selected as it is negative NPV

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