Romanos Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year. The capital budget is limited to $6,000,000 for the year. Laura Babson, staff analyst at Romanos, is preparing an analysis of the three projects under consideration by Calvin Romanos, the company's owner.

ABCD1 Project AProject BProject C2Projected cash outflow 3Net initial investment$3,000,000 $1,500,000 $4,000,000 4Projected cash inflows 5Year 1$1,000,000 $400,000 $2,000,000 6Year 21,000,000900,0002,000,0007Year 31,000,000800,000200,0008Year 41,000,000 100,0009Required rate of return12%12%12%

1.

Because the company's cash is limited,

Romanos

thinks the payback method should be used to choose between the capital budgeting projects.

a.What are the benefits and limitations of using the payback method to choose between projects? b.

Calculate the payback period for each of the three projects. Ignore income taxes. Using the payback method, which projects should

Romanos

choose?

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.

3.Which projects, if any, would you recommend funding? Briefly explain why.