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ID: 2482449 • Letter: L
Question
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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.Project Bono Project Edge Project Clayton Capital investment $168,000 $183,750 $202,000 Annual net income: Year 1 14,700 18,900 28,350 2 14,700 17,850 24,150 3 14,700 16,800 22,050 4 14,700 12,600 13,650 5 14,700 9,450 12,600 Total $73,500 $75,600 $100,800
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.)
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Explanation / Answer
1)
Annual deprectaion for project Bono = 168,000 / 5 = $33,600
Annual operating cash flow for project Bono = annual net income + depreciation
Annual operating cash flow for project Bono = 14,700 + 33,600 = $48,300
Payback period for project bono = 168,000 / 48,300
Payback period for project bono = 3.48 years
Annual depreciation for project edge = 183,750 / 5 = 36,750
operating cash flow for year 1 = 18,900 + 36,750 = $55,650
Operating cash flow for year 2 = 17,850 + 36,750 = 54,600
Operating cash flow for year 3 = 16,800 + 36,750 = 53,550
Operating cash flow for year 4 = 12,600 + 36,750 = 49,350
Operating cash flow for year 5 = 9,450 + 36,750 = 46,200
Cumulative cash flow for year 0 = -183,750
Cumulative cash flow for year 1 = -183,750 + 55,650 = -128,100
Cumulative cash flow for year 2 = -128,100 + 54,600 = -73,500
Cumulative cash flow for year 3 = -73,500 + 53,550 = -19,950
Cumulative cash flow for year 4 = -19,950 + 49,350 = 29,400
19,950 / 49,350 = 0.404
Payback period for project edge= 3 + 0.404 = 3.4 years
Annual depreciation for project Clayton = 202,000 / 5 = 40,400
operating cash flow for year 1 = 28,350 + 40,400 = 68,750
Operating cash flow for year 2 = 24,150 + 40,400 = 64,550
Operating cash flow for year 3 = 22,050 + 40,400 = 62,450
Operating cash flow for year 4 = 13,650 + 40,400 = 54,050
Operating cash flow for year 5 = 12,600+ 40,400 = 53,000
Cumulative cash flow for year 0 = -202,000
Cumulative cash flow for year 1 = -202,000 + 68,750 = -133,250
Cumulative cash flow for year 2 = -133,250 + 64,550 = -68,700
Cumulative cash flow for year 3 = -68,700 + 62,450 = -6,250
Cumulative cash flow for year 4 = -6,250 + 54,050 = 47,800
6,250 / 54,050 = 0.115
Payback period for clayton= 3 + 0.115 = 3.12 years
2)
Net present value = present value of cash inflows - present value of cash outflows
Net present value of project Bono = -168,000 + 48,300 / ( 1 + 0.15)1 + 48,300 / ( 1 + 0.15)2 + 48,300 / ( 1 + 0.15)3 + 48,300 / ( 1 + 0.15)4 + 48,300 / ( 1 + 0.15)5
Net present value of project Bono = -$6,090.91
Net present value of project Edge = -183,750 + 55,650 / ( 1 + 0.15)1 + 54,600 / ( 1 + 0.15)2 + 53,550 / ( 1 + 0.15)3 + 49,350 / ( 1 + 0.15)4 + 46,200 / ( 1 + 0.15)5
Net present value of project Edge = -7,677.67
Net present value of project Clayton = -202,000 + 68,750 / ( 1 + 0.15)1 + 64,550 / ( 1 + 0.15)2 + 62,450 / ( 1 + 0.15)3 + 54,050 / ( 1 + 0.15)4 + 53,000 / ( 1 + 0.15)5
Net present value of project Clayton = 4,907.2
c)
Annual rate of return = (average net income / average book value) * 100
Avrage book value of project Bono= 168,000 - 0 / 2
Avrage book value project Bono = 84,000
Average net income = 73,500 / 5 = 14,700
Annual rate of return for project Bono =( 14,700 / 84,000) * 100
Annual rate of return for project Bono = 17.5%
Avrage book value of project Edge = 183,750 - 0 / 2
Avrage book value project Edge = 91,875
Average net income = 75,600 / 5 = 15,120
Annual rate of return for project Edge =( 15,120 / 91,875) * 100
Annual rate of return for project Edge = 16.46%
Avrage book value of project Clayton = 202,000 - 0 / 2
Avrage book value project Clayton = 101,000
Average net income = 100,800 / 5 = 20,160
Annual rate of return for project Clayton =( 20,160 / 101,000) * 100
Annual rate of return for project Clayton = 19.96%
Annual rate of return for project Clayton = 16.46%
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