Problem:
Henkel Company is
considering three long-term capital investment proposals. Each investment has a
useful life of 5 years. Relevant data on each project are as follows.
Project
Kilo Project Lima Project Oscar
Capital Investment 150,000 165,000 200,000
Annual net income:
Year 1 14000 18000 27000
2 14000 17000 23000
3 14000 16000 21000
4 14000 12000 13000
5 14000 9000 12000
Total 70,000 72,000 96,000
.:.
Depreciation is
computed by the straight-line method with no salvage value. The company’s cost
of capital is 15%. (Assume that cash flows occur evenly throughout the year.)
Instructions
(a) Compute the
cash payback period for each project. (Round to two decimals.)
(b) Compute the net
present value for each project. (Round to nearest dollar.)
(c) Compute the
annual rate of return for each project. (Round to two decimals.)
(d) Rank the
projects on each of the foregoing bases. Which project do you recommend?
(a) Project Kilo
$150,000 ÷ ($14,000 + $30,000) = 3.41 years
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Project
Lima
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Year
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Cash
Flow
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Cumulative
Cash Flow
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1
2
3
4
5
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$51,000
($18,000 + $33,000)
$50,000
($17,000 + $33,000)
$49,000
($16,000 + $33,000)
$45,000
($12,000 + $33,000)
$42,000
($ 9,000 + $33,000)
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$ 51,000
$101,000
$150,000
$195,000
$237,000
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Cash payback period 3.33 years
$165,000 – $150,000 = $15,000
$15,000 ÷ $45,000 = .33
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Project
Oscar
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Year
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Cash
Flow
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Cumulative
Cash Flow
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1
2
3
4
5
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$67,000
($27,000 + $40,000)
$63,000
($23,000 + $40,000)
$61,000
($21,000 + $40,000)
$53,000
($13,000 + $40,000)
$52,000
($12,000 + $40,000)
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$ 67,000
$130,000
$191,000
$244,000
$296,000
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Cash payback period 3.17 years
$200,000 – $191,000 = $9,000
$9,000 ÷ $53,000 = .17
(b) Project
Kilo
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Item
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Amount
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Years
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PV
Factor
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Present
Value
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Net annual cash flows
Capital investment
Negative net present
value |
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$44,000
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1–5
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3.35216
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$147,495
(150,000)
$ (2,505)
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Project Lima
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Project Oscar
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Year
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Discount
Factor
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Cash
Flow
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PV
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Cash
Flow
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PV
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1
2
3
4
5
Total
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.86957
.75614
.65752
.57175
.49718
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$ 51,000
50,000
49,000
45,000
42,000
$237,000
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$
44,348
37,807
32,218
25,729
20,882
160,984
(165,000)
$ (4,016)
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$ 67,000
63,000
61,000
53,000
52,000
$296,000
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$
58,261
47,637 40,109
30,303
25,853
202,163
(200,000)
$ 2,163
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Capital investment
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Positive (negative)
net present value
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(c) Project Kilo = $14,000 ÷ [($150,000 + $0) ÷ 2] =
18.67%.
Project Lima = $14,400 ÷ [($165,000 + $0) ÷ 2] =
17.5%.
Project
Oscar = $19,200 ÷ [($200,000 + $0) ÷
2] = 19.2%.
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(d)
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Project
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Cash
Payback
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Net
Present
Value
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Annual
Rate
of Return
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Kilo
Lima
Oscar
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3
2
1
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2
3
1
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2
3
1
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