QUESTION 2 Andrews Construction is analyzing its capital expenditure proposals f
ID: 2595500 • Letter: Q
Question
QUESTION 2 Andrews 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.The staff analyst at Andrews is preparing an analysis of the three projects under construction by Corey Andrews the owner of the company. Information gathered is as follows: Project A Project B Project C Projected Cash outflow Net Initial Investment 3,000,000 1,500,0004,000,000 Projected Cash Inflows Year 1 Year 2 Year 3 Year 4 1,000,000 1,000,000 1,000,000 1,000,000 400,000 2,000,000 900,000 2,000,000 200,000 100,000 800,000 The company requires a rate of return of 10% or higher on each of these projects 1. As the major concern of the company is the limited cash available it was suggested that they should do the project with the earliest payback. Comment showing your calculations in support of the decision. 2. It was also suggested that the NPV method was a better basis for selection. Calculate the NPV and IRR for each of the project and rank them in terms of the benefit to the company 3. Which project do you think should be funded in the coming year?Explanation / Answer
Answer 1. Project A Cash Payback = Intial Investment / Annual Cash Inflow Cash Payback = $3,000,000 / $1,000,000 Cash Payback = 3 Years Project B Year Cash Inflow Accumulated Net Cash Inflow 1 400,000 400,000 2 900,000 1,300,000 3 800,000 2,100,000 Cash payback period = 2 Years + (200,000 / 800,000 x 1 Year) Cash payback period = 2 Years + 0.25 Cash payback period = 2.25 Years Project C Year Cash Inflow Accumulated Net Cash Inflow 1 2,000,000 2,000,000 2 2,000,000 4,000,000 3 200,000 4,200,000 4 100,000 4,300,000 Cash payback period = 2 Years + (0 / 200,000 x 1 Year) Cash payback period = 2 Years + 0 Cash payback period = 2 Years Project A Project B Project C Cash Payback Period 3 Years 2.25 Years 2 Years Ranking III II I Answer 2. Year 0 1 2 3 4 Project A Cash Inflow (3,000,000) 1,000,000 1,000,000 1,000,000 1,000,000 PV Factor - 10% 1.00000 0.90909 0.82645 0.75131 0.68301 Present Value (3,000,000) 909,090 826,450 751,310 683,010 NPV 169,860 Project B Cash Inflow (1,500,000) 400,000 900,000 800,000 - PV Factor - 10% 1.00000 0.90909 0.82645 0.75131 0.68301 Present Value (1,500,000) 363,636 743,805 601,048 - NPV 208,489 Project C Cash Inflow (4,000,000) 2,000,000 2,000,000 200,000 100,000 PV Factor - 10% 1.00000 0.90909 0.82645 0.75131 0.68301 Present Value (4,000,000) 1,818,180 1,652,900 150,262 68,301 NPV (310,357) IRR Year Project A Project B Project C Intial Investment 0 (3,000,000) (1,500,000) (4,000,000) Expcted Net Cash inflow 1 1,000,000 400,000 2,000,000 2 1,000,000 900,000 2,000,000 3 1,000,000 800,000 200,000 4 1,000,000 - 100,000 Internal Rate of Return 12.59% 16.96% 4.57% Project A Project B Project C Net Present Value 169,860 208,489 (310,357) IRR 12.59% 16.96% 4.57% Ranking II I III Answer 3. Project B should be funded in the comping year. Project B has the highest NPV and IRR.