The partnership of Lou and Bud is considering three long-term capital investment proposals. Relevant data on each project are as follows:
Project Brown
Project Red
Project Yellow
Capital investment:
$140,000
$170,000
$190,000
Annual net income:
Year 1
$ 9,000
$ 12,500
$ 19,000
2
9,000
12,000
15,000
3
9,000
11,000
14,000
4
9,000
8,000
9,000
5
9,000
6,000
8,000
Total
$ 45,000
$ 49,500
$ 65,000
The salvage value is expected to be zero at the end of each project. Depreciation is calculated by the straight-line method. The company’s required rate of return is the company’s cost of capital, which is 12%. (Use average net annual cash flows in your calculations.)
Instructions
Calculate the cash payback period for each project. (Round to two decimals.)
a. Project Brown: 3.78 years Project Red: 3.87 years Project Yellow: 3.73 years
Calculate the net present value for each project. (Round to the nearest dollar.)
Calculate the average annual rate of return for each project. (Round to two decimals.) (Hint: Use average annual net income in your calculation.)
Rank the projects based on each of your answers in parts (a), (b), and (c). Which project do you recommend?
