U3 Company is considering three longterm capital investment

U3 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 Bono Project Edge Project Clayton Capital investment $174,400 $190,750 $218,000 Annual net income: Year 1 15,260 19,620 29,430 2 15,260 18,530 25,070 3 15,260 17,440 22,890 4 15,260 13,080 14,170 5 15,260 9,810 13,080 Total $76,300 $78,480 $104,640 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.) Click here to view PV table. Compute the cash payback period for each project

Solution

To calculate cash payback period, firstly calculate the cash flow from project that in this case = Net Income + Annual Depreciation Charge. Because depreciation is a non-cash expense.

Annual Depreciation on Project Bono = 174,400 / 5 = 34,880

Annual Depreciation on Project Edge = 190,750 / 5 = 38,150

Annual Depreciation on Project Clayton = 218,000 / 5 = 43,600

Answer-1:

Project Bono

Year

Net Income

Annual Depreciation

Cash Inflows

1

15260

34880

50140

2

15260

34880

50140

3

15260

34880

50140

4

15260

34880

50140

5

15260

34880

50140

Cash Payback Period = Total Investment / Annual Cash Inflow

                                      = 174,400 / 50,140

                                      = 3.478 years

Answer-2:

Project Edge

Year

Net Income

Annual Depreciation

Cash Inflows

Cumulative Cash Inflow

1

19620

38150

57770

57770

2

18530

38150

56680

114450

3

17440

38150

55590

170040

4

13080

38150

51230

221270

5

9810

38150

47960

269230

Cumulative cash flow shows that, total investment of $ 190,750 will be recovered in between 3 to 4 year, Cash Payback Period;

   = 3 years + (190,750 – 170,040)/51,230

= 3 years + 20710 / 51230

= 3 years + 0.404 year

= 3.404 years.

Answer-3:

Project Clayton

Year

Net Income

Annual Depreciation

Cash Inflows

Cumulative Cash Inflow

1

29430

43600

73030

73030

2

25070

43600

68670

141700

3

22890

43600

66490

208190

4

14170

43600

57770

265960

5

13080

43600

56680

322640

Cumulative cash flow shows that, total investment of $ 218,000 will be recovered in between 3 to 4 year, Cash Payback Period;

= 3 years + (218,000 – 208,190)/57,770

= 3 years + 9,810 / 57,770

= 3 years + 0.169 year

= 3.169 years

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	Project Bono
Year	Net Income	Annual Depreciation	Cash Inflows
1	15260	34880	50140
2	15260	34880	50140
3	15260	34880	50140
4	15260	34880	50140
5	15260	34880	50140