Exercise 12-2 Doug\'s Custom Construction Company is considering three new proje

Question

Exercise 12-2 Doug's Custom Construction Company is considering three new projects, each requiring an equipment investment of $23,100. Each project will last for 3 years and produce the following net annual cash flows Year ?? $7,350 $10,500 $13,650 9,450 10,500 12,600 12,600 10,500 11,550 Total $29,400 $31,500 $37,800 The equipment's salvage value is zero, and Doug uses straight-line depreciation. Doug will not accept any project with a cash payback period over 2 years. Doug's required rate of return is 12%. Click here to view PV table. Compute each project's payback period. (Round answers to 2 decimal places, e.g. 15.25.) years years years Which is the most desirable project? The most desirable project based on payback period is Project AA Project BB Project CC Which is the least desirable project? The least desirable project based on payback period is

Explanation / Answer

a) Project AA: Year Cash flow Cumulative Cash flow 0 -23100 -23100 1 7350 -15750 2 9450 -6300 3 12600 6300 Payback period = 2+6300/12600 = 2.50 years Project BB: Payback period = 23100/10500 = 2.20 years Project CC: Year Cash flow Cumulative Cash flow 0 -23100 -23100 1 13650 -9450 2 12600 3150 3 11550 14700 Payback period = 1+9450/12600 = 2.20 years. Most desirable project is Project BB and Project CC as they both have the lowest payback period. Least desirable project is Project AA. However, all the three projects have PB more than the maximum permissible PB of 2 years. b) Project AA: Year Cash flow PVIF at 12% PV at 12% 0 -23100 1 -23100 1 7350 0.89286 6563 2 9450 0.79719 7533 3 12600 0.71178 8968 NPV = $               -36 Project BB: NPV = 10500*2.40183-23100 = $    2,119.22 Project CC: Year Cash flow PVIF at 12% PV at 12% 0 -23100 1 -23100 1 13650 0.89286 12188 2 12600 0.79719 10045 3 11550 0.71178 8221 NPV = $          7,353 Most desirable project based on NPV is Project CC. The lease desirable project based on NPV is Project AA.

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