Managerial Accounting
Problem P12-1B
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 $200,000 $225,000 $250,000
Annual net income
Year 1 $25,000 $20,000 $26,000
Year 2 16,000 20,000 24,000
Year 3 13,000 20,000 23,000
Year 4 10,000 20,000 22,000
Year 5 8,000 20,000 20,000
Total $72,000 $100,000 $115,000
Salvage value is expected to be zero at the end of each project. Depreciation is computed by the straight-line method. The company's required rate of return is the company's cost of capital which is 12%. (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.) (Hint: Use average annual net income in your computation.)
(d) Rank the projects on each of the foregoing bases. Which project do you recommend?