Problem 26-5A (Part Level Submission) Project Kilo Project Lima Project Oscar (a

Question

Problem 26-5A (Part Level Submission)

Project Kilo

Project Lima

Project Oscar

(a)

Cash Payback

Problem 26-5A (Part Level Submission)

Henkel 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 Kilo

Project Lima

Project Oscar

Capital investment $149,500 $164,900 $200,200 Annual net income: Year 1 13,876 17,930 26,949 2 13,876 17,010 22,890 3 13,876 16,120 20,940 4 13,876 11,850 13,167 5 13,876 9,173 11,890 Total $69,380 $ 72,083 $95,836
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.)

Explanation / Answer

Payback period is the period within which the initial investment is recovered by the company with the use of cash flows. We will have to calculate the annual cash flows for each project.

The annual cash flow tables for each project are given below:

_____

_____

_________

Now, we can calculate the payback period.

Payback Period (Kilo) = Initial Investment/Constant Annual Cash Flow = 149,500/43,776 = 3.42 Years

_________

Payback Period (Lima)

The initial investment of $164,900 will get recovered as follows:

Year 1 Cash Flow = 50,910

Year 2 Cash Flow = 49,990

Year 3 Cash Flow = 49,100

and the balance amount of $14,900 (164,900 - 50,910 - 49,990 - 49,100) between Year 3 and 4. The formula for calculating payback with non constant cash flows is given below:

Payback Period = Years upto which Partial Recovery is Made + Balance/Cash Flow of the Year in which Full Recovery is Made

Payback Period (Lima) = 3 + 14,900/44,830 = 3.33 Years

_________

Payback Period (Oscar)

The initial investment of $200,200 will get recovered as follows:

Year 1 Cash Flow = 66,989

Year 2 Cash Flow = 62,930

Year 3 Cash Flow = 60,980

and the balance amount of $9,301 (200,200 - 66,989 - 62,930 - 60,980) between Year 3 and 4. The formula for calculating payback with non constant cash flows is given below:

Payback Period = Years upto which Partial Recovery is Made + Balance/Cash Flow of the Year in which Full Recovery is Made

Payback Period (Oscar) = 3 + 9,301/53,207 = 3.17 Years

_________

Tabular Representation:

Project Kilo – Cash Flows Year Net Income Depreciation Annual Cash Flow (Net Income + Depreciation) 1 13,876 29,900 43,776 2 13,876 29,900 43,776 3 13,876 29,900 43,776 4 13,876 29,900 43,776 5 13,876 29,900 43,776

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