Accounting : Payback Period and Net Present Value
Suzaki Manufacturing Company is considering three new projects, each requiring an equipment investment of $22,000. Each project will last for 3 years and produce the following cash inflows.
Year AA BB CC
1 $ 7,000 $ 9,500 $13,000
2 9,000 9,500 10,000
3 15,000 9,500 9,000
Total $31,000 $28,500 $32,000
The equipment's salvage value is zero. Suzaki uses straight-line depreciation. Suzaki will not accept any project with a payback period over 2 years. Susaki's minimum required rate of return is 12%.
a) Compute each project's payback period, indication the most desirable project and the least desirable project using this method. (Round to two decimals).
b)Compute the net present value of each project. Does your evaluation change? (Round to the nearest dollar)
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Cumulative cash flow -22,000 -9,000 1,000 10,000
Payback AA = 1 + 9,000/10,000 = 1.9 years
In terms of payback period, the most desirable project will be Project CC. This is because its payback period is less than 2 years as Suzaki stated that it will not accept any project with a payback period over 2 years. Both Project AA and CC have payback period of more than 2 years.
The least desirable project will be Project AA. This is because Project AA has the longest time required for the equipment investment's net revenues to cover its cost.
b. Project AA's NPV:
Using TI BA II PLUS financial calculator, enter the following,
CF, 22000, +/-, enter