Requirements: 1. Compute the payback, the NPV, and the profitability index of th
ID: 2483172 • Letter: R
Question
Requirements:
1. Compute the payback, the NPV, and the profitability index of these two plans.
2. Which expansion should Leches choose? Why?
Learning Objectives 2, 4 P26-30A Using payback, ARR, NPV, IRR, and profitability index to make capital investment decisions 1. Plan A 1.10 profitability index; Plan B $(1,227,400) NPV Leches operates a chain of sandwich shops. The company is considering (wo possible expansion plans. Plan A would open eight smaller shops at a cost of $8,400,000. Expected annual net cash inflows are $1,500,000, with zero residual value at the end of 10 years. Under Plan B, Leches would open three larger shops at a cost of $8,250,000. This plan is expected to generate net cash inflows of $1,080,000 per year for 10 years, the estimated useful life of the proper ties. Estimated residual value for Plan B is $1,000,000. Leches uses straight-line depreciation and requires an annual return of 10%.Explanation / Answer
Pay-back period for plan A = 1500000 x 5 = 7500000.
900000 / 1500000 = 0.6 year
= 5 year + 0.6 year = 5.6 year.
Pay-back period for plan B = 1080000 x 7 = 7560000.
690000 / 1080000 = .64 year
= 7 year + .64 year = 7.64 year.
Calculation of Net present Value of plan A =
Year
Cash inflow
Table Value at 10%
Present value
1
1500000
.90909
1363635
2
1500000
.82654
1239810
3
1500000
.75131
1126965
4
1500000
.68301
1024515
5
1500000
.62092
931380
6
1500000
.56447
846705
7
1500000
.51361
770415
8
1500000
.46651
699765
9
1500000
.42410
636150
10
1500000
.38554
578310
Total
9217650
Net present value of plan A = 9217650 – 8400000 = $817650
Calculation of Net present Value of plan B =
Year
Cash inflow
Table Value at 10%
Present value
1
1080000
.90909
981817.2
2
1080000
.82654
892663.2
3
1080000
.75131
811414.8
4
1080000
.68301
737650.8
5
1080000
.62092
670593.6
6
1080000
.56447
609627.6
7
1080000
.51361
554698.8
8
1080000
.46651
503830.8
9
1080000
.42410
458028
10
1080000
.38554
416383.2
Total
6636708
Net present value of plan A = 6636708 – 8250000 = ($1613292)
Profitability index of plan A = 9217650 / 8400000 = 1.097
Profitability index of plan B = 6636708 / 8250000 = 0.804
On the basis of above data it can be said that Leches should choose Plan – A because this plan has lower pay-back period, higher NPV and higher profitability index.
Year
Cash inflow
Table Value at 10%
Present value
1
1500000
.90909
1363635
2
1500000
.82654
1239810
3
1500000
.75131
1126965
4
1500000
.68301
1024515
5
1500000
.62092
931380
6
1500000
.56447
846705
7
1500000
.51361
770415
8
1500000
.46651
699765
9
1500000
.42410
636150
10
1500000
.38554
578310
Total
9217650
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