15,000 9,500 11,000 $31,000 $28,500 $34,000 The equipment\'s salvage value is ze
ID: 2348391 • Letter: 1
Question
15,000
9,500
11,000
$31,000
$28,500
$34,000
The equipment's salvage value is zero, and Chris uses straight-line depreciation. Chris will not accept any project with a cash payback period over 2 years. Chris's required rate of return is 12%.
The most desirable project based on payback period is .
The least desirable project based on payback period is .
The most desirable project based on net present value is .
The least desirable project based on net present value is .
E12-2 Chris's Custom Manufacturing Company is considering three new projects, each requiring an equipment investment of $21,000. Each project will last for 3 years and produce the following net annual cash flows.Year AA BB CC
1 $7,000 $9,500 $13,000
2 9,000 9,500 10,000
3
15,000
9,500
11,000
Total
$31,000
$28,500
$34,000
The equipment's salvage value is zero, and Chris uses straight-line depreciation. Chris will not accept any project with a cash payback period over 2 years. Chris's required rate of return is 12%.
Explanation / Answer
Payback period
AA = 2 + 5000/15000 = 2.33 years
BB = 2 + 2000/9500 = 2.21 years
CC = 1 + 8000/10000 = 1.80 years
The most desirable project based on payback is CC, while the least desirable project based on payback is AA.
Net Present Value
Discount rate 12%
Year 1 = 1/1.12 = 0.89286
Year 2 = 1/1.122 = 0.79719
Year 3 = 1/1.123 = 0.71178
NPV of AA = -21000 + 7000 x 0.89286 + 9000x0.79719 + 15000 x 0.71178 = $3101
NPV of BB = -21000 + 9500 x 0.89286 + 9500x0.79719 + 9500 x 0.71178 = $1817
NPV of CC = -21000 + 13000 x 0.89286 + 10000x0.79719 + 11000 x 0.71178 = $6409.
The most desirable project based on net present value is CC.
The least desirable project based on net present value is BB.
Hope this helps!