Henkel Company is considering three long-term capital investment proposals. Each

Question

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 $158,100 $168,300 $210,600 Annual net income: Year 1 13,260 17,850 28,050 2 13,260 16,830 22,950 3 13,260 15,810 21,930 4 13,260 11,730 13,770 5 13,260 8,670 12,750 Total $66,300 $70,890 $99,450 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.) Click here to view the factor table. (For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Collapse question part (a) Compute the cash payback period for each project. (Round answers to 2 decimal places, e.g. 10.50.) Project Kilo years Project Lima years Project Oscar years

Explanation / Answer

Answer:

Cash payback period = Cost of the project/ Annual cash flow

Since net income is given in the problem, thereforee, firstly we need to calculate annual cash flow. Annual cash flow is calculated as:

Annual cash flow = Net income + Non cash expenditure (Depreciation)

Since the company uses straight line method of depreciation, therefore according to this method, depreciation is calculated as:

Depreciation = Cost of the investment/ Estimated useful life of the investment

Calculations for Project Kilo:

Depreciation = $158100 / 5years = $31620

Cash payback period = 158100/ (13260 annual net income+ 31620 annual dep.)

Cash payback period = 158100 /44880 = 3.52 years

Calculations for Project Lima:

Depreciation = $168300 / 5 years = $33660

$151470 cost of the project can be recovered in 3 years.

The recovery of remaining cost would be calculated as:

Amount left to pay back from the 4th year's cash flow = Cost of the investment - Cumulative cash inflow for 3 years

Amount left to pay back from the 4th year's cash flow = 168300 - 151470 = 16830

Cash payback period for this $16830 remaining cost of the project = 16830 / 45390 cash flow in 4th year

Cash payback period for this $16830 remaining cost of the project = 0.37 years

It implies it takes near about one third of the 4th year to finish the payback.

Thus, payback period for Project Lima = 3 years + 0.37 years= 3.37 years

Calculation for Project Oscar:

Depreciation = $210600 / 5 years = $42120

$199290 cost of the project can be recovered in 3 years.

The recovery of remaining cost would be calculated as:

Amount left to pay back from the 4th year's cash flow = Cost of the investment - Cumulative cash inflow for 3 years

Amount left to pay back from the 4th year's cash flow = 210600 - 199290 = 11310

Cash payback period for this $11310 remaining cost of the project = 11310 / 55890 cash flow in 4th year

Cash payback period for this $11310 remaining cost of the project = 0.20 years

Thus, payback period for Project Oscar = 3 years + 0.20 years= 3.20 years

Payback period for all 3 projects is:

Annual cash flow for Project Lima Year Annual Net income Annual Depreciation Annual cash flow Cumulative cash inflow 1 17850 33660 51510 51510 2 16830 33660 50490 102000 3 15810 33660 49470 151470 4 11730 33660 45390 196860 5 8670 33660 42330 239190

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