Davis Company is considering two capital investments proposals. Estimates regard

Question

Davis Company is considering two capital investments proposals. Estimates regarding each project are provided.
Project A Project B
Initial Investment 800,000 650,000
Annual Net Income 50,000 45,000
Annual Cash Inflow 220,000 200,000
Estimated Useful life 5 yrs 4 yrs
Salvage Value 0 0

The company requires a 10% rate of return on all new investments.
Part A- Calculate the payback period for each project
Part b- Calculate the net present value for each project
Part C- Which project should they accept and why?

Explanation / Answer

PROJECT A

INTEREST RATE = 10%=0.1

DISCOUNT RATE PER YEAR = 1.1

USEFULL LIFE=5 YRS.

SALVAGE VALUE = 0

YEAR

INFLOW

OUTFLOW

NET

DCF

1

800000

-800000

-800000

2

220000

170000

50000

45455

3

220000

170000

50000

41322

4

220000

170000

50000

37566

5

220000

170000

50000

34151

TOTAL NET INFLOW =

-600000

NPV=

-641507

SINCE NET INFLOW IS STILL NEGATIVE AT

THE END OF USEFULL LIFE OF 5 YEARS

THERE IS NO QUESTION OF PAY BACK PERIOD.

PROJECT B

INTEREST RATE = 10%=0.1

DISCOUNT RATE PER YEAR = 1.1

USEFULL LIFE=4 YRS.

SALVAGE VALUE = 0

YEAR

INFLOW

OUTFLOW

NET

1

650000

-650000

-650000

2

200000

155000

45000

40909

3

200000

155000

45000

37190

4

200000

155000

45000

33809

TOTAL NET INFLOW =

-515000

NPV=

-538092

SINCE NET INFLOW IS STILL NEGATIVE AT

THE END OF USEFULL LIFE OF 4 YEARS

THERE IS NO QUESTION OF PAY BACK PERIOD.

BOTH ARE LOSS YIELDING PROPOSITIONS.

PROJECT B HAS LESSER NEGATIVE NPV THAN PROJECT A

SO BETWEEN THE TWO,PROJECT B IS BETTER.

PROJECT A

INTEREST RATE = 10%=0.1

DISCOUNT RATE PER YEAR = 1.1

USEFULL LIFE=5 YRS.

SALVAGE VALUE = 0

YEAR

INFLOW

OUTFLOW

NET

DCF

1

800000

-800000

-800000

2

220000

170000

50000

45455

3

220000

170000

50000

41322

4

220000

170000

50000

37566

5

220000

170000

50000

34151

TOTAL NET INFLOW =

-600000

NPV=

-641507

SINCE NET INFLOW IS STILL NEGATIVE AT

THE END OF USEFULL LIFE OF 5 YEARS

THERE IS NO QUESTION OF PAY BACK PERIOD.

PROJECT B

INTEREST RATE = 10%=0.1

DISCOUNT RATE PER YEAR = 1.1

USEFULL LIFE=4 YRS.

SALVAGE VALUE = 0

YEAR

INFLOW

OUTFLOW

NET

1

650000

-650000

-650000

2

200000

155000

45000

40909

3

200000

155000

45000

37190

4

200000

155000

45000

33809

TOTAL NET INFLOW =

-515000

NPV=

-538092

SINCE NET INFLOW IS STILL NEGATIVE AT

THE END OF USEFULL LIFE OF 4 YEARS

THERE IS NO QUESTION OF PAY BACK PERIOD.

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