E26-2 Compute cash payback period and net present value Doug's Custom Construction Company is considering three new projects, each requiring an equipment investment of $22,000. Each project will last for 3 years and produce the following net annual cash flows 5 7 8 9 0 11 Year 1 2 3 Total AA $7,000 9,000 12,000 $28.000 BB $10,000 10,000 10,000 $30,000 CC $13,000 12,000 11,000 $36,000 2 The equipment's salvage value is zero, and Doug uses straight-line depreciation. Doug will not -3 accept any project with a cash payback period over 2 years. Doug's required rate of return is 12%. 15 Instructions 37 18 6 (a) Compute each project's payback period, indicating the most desirable project and the least desirable project using this method. (Round to two decimals and assume in your computations that cash flows occur evenly throughout the year.) 19 (0) Compute the net present value of each project. Does your evaluation change? (Round to nearest dollar.) 21 NOTE: Enter a number in cells requesting a value; enter either a number or a formula in cells with a "?". 20 R2 23 es (a) 26 27 28 Compute each project's payback period, indicating the most desirable project and the least desirable project using this method. (Round to two decimals and assume in your computations that cash flows occur evenly throughout the year.) 30 81 82 33 Year 1 2 3 Project AA Net Annual Cash Flow $7,000 9,000 12,000 Cumulative Net Cash Flow ($15,000) ($6,000) $6,000 G H K M 3 12,000 D $6,000 34 35 36 37 38 39 Value 40 Cash Payback Period: Cost of capital investment Cumulative net cash flow, year 2 Remaining cost to be recovered (a) Net cash flow, year 3 (b) Payback period, yoar 3 (a) + (b) Total cash payback period in years ? Value 41 42 43 44 45 46 47 Project BB 48 Cash Payback Period: Cost of capital investment (a) Net annual cash flow Total cash payback period in years (a) + (b) Value Value ? 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 Year 1 2 3 Project CC Net Annual Cumulative Cash Flow Net Cash Flow $13,000 ($9,000) 12.000 $3,000 11.000 $14,000 64 Cash Payback Period: Cost of capital investment Cumulative net cash flow, year 1 Remaining cost to be recovered (a) Net cash flow, year 2 (b) Payback period, year 2 (a) + (b) Value Value 2 Value Value 66 67 F G H D 1 1 M K N Payback period, year 2 (a)+(b) Total cash payback period in years E Value 2 Response: The most desirable project is Project CC because it's payback period is less than 2 years. The least desirable project is Project AA because it's payback period is 2.5 years which is longer than BB and CC Projects. A 62 68 69 70 71 72 73 74 75 76 77 78 79. (b) 30 81 82 83 + Compute the net present value of each project. Does your evaluation change? (Round to nearest dollar) 84 85 86 82 BR 89 90 12% Discount Year Factor 1 0.89286 2 0.79719 3 0.71178 Total present value Investment Net present value Project AA Cash Present Flow Value $7,000 $6,250 9,000 7,175 12,000 8,541 ? Value ($34) Project BB Cash Present Flow Value $10,000 $8.929 10,000 7,972 10,000 7.118 ? Value $2,019 Project CC Cash Present Flow Value $13,000 $11.607 12,000 9,566 11,000 7,830 ? Value $7,003 91 92 93 94 Response: The most diserable project is Project CC because it has the highest positive net present value while Project AA has the least because it has the negative net present value. 95 96 97 98 99
