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Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year. The capital budget is limited to $5,000,000 for the
Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year. The capital budget is limited to $5,000,000 for the year. Jenny, staff analyst at Chris Andrews, is preparing an analysis of the three projects under consideration by Chris, the company's owner.
A B D 1 Project A Project B Project C 2 Projected cash outflow 3 Net initial investment $ 3,000,000 $ 2,100,000 $ 3,000,000 4 Projected cash inflows 5 Year 1 6 Year 2 $ 1,200,000 $ 1,200,000 $ 1,700,000 1,200,000 600,000 1,700,000 1,200,000 500,000 200,000 7 Year 3 8 Year 4 1,200,000 100,000 9 Required rate of return 6% 6% 6% Benefits of the payback method: A. Indicates whether or not the project will earn the company's minimum required rate of return B. Utilizes the time value of money and computes each project's unique rate of return C. Easy to understand and captures uncertainty about expected cash flows in later years of a project D. All of the above Limitations of the payback method: A. Cannot be used when management's required rate of return varies from one period to the next. B. Cannot be used for projects with unequal periodic cash flows C. Fails to incorporate the time value of money and does not consider a project's cash flows after the payback period D. All of the above b. Calculate the payback period for each of the three projects. Ignore income taxes. (Round your answers to two decimal places.) years Project A Project B Project C years years 2. Babson thinks that projects should be selected based on their NPVs. Assume all cash flows occur at the end of the year except for initial investment amounts. Calculate the NPV for each project. Ignore income taxes. Which projects, if any, would you recommend funding? Briefly explain why. 3Step by Step Solution
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