RozzisRozzis

Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year. The capital budget is limited to

$ 5 comma 000 comma 000$5,000,000

for the year.

LindaLinda

BensonBenson?,

staff analyst at

RozzisRozzis?,

is preparing an analysis of the three projects under consideration by

ChesterChester

RozzisRozzis?,

the? company's owner.

Requirement 1. Because the? company's cash is? limited,

RozzisRozzis

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?

Benefits of the payback? method:

A.

Easy to understand and captures uncertainty about expected cash flows in later years of a project

Your answer is correct.

B.

Indicates whether or not the project will earn the? company's minimum required rate of return

C.

Utilizes the time value of money and computes each? project's unique rate of return

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

Data Table:

Project A

Project B

Project C

Projected cash outflow

Net initial investment

$3,000,000

$2,100,000

$3,000,000

Projected cash inflows

Year 1

$1,200,000

$1,200,000

$1,700,000

Year 2

1,200,000

600,000

1,700,000

Year 3

1,200,000

500,000

200,000

Year 4

1,200,000

100,000

Required rate of return

8%

8%

8%

Requirements:

1.	Because the? company's cash is? limited, RozzisRozzis 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 RozzisRozzis ?choose?
2.	BensonBenson 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.