Kaleb
Konstruction, Inc., has the following mutually exclusive projects
available. The company has historically used a three-year cutoff for
projects. The required return is 11 percent.
| Year | Project F | Project G | ||
| 0 | –$ | 139,000 | –$ | 209,000 |
| 1 | 58,000 | 38,000 | ||
| 2 | 52,000 | 53,000 | ||
| 3 | 62,000 | 92,000 | ||
| 4 | 57,000 | 122,000 | ||
| 5 | 52,000 | 137,000 | ||
| | ||||
| Required: |
| (a) |
Calculate the payback period for both projects. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
|
| Payback period | |
| Project F | years |
| Project G | years |
| | |
| (b) |
Calculate the NPV for both projects. (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)
|
| Net present value | |
| Project F | $ |
| Project G | $ |
| | |
| (c) | Which project should the company accept? |
| Project G |
Explanation:
| (a) |
| The payback period for each project is: |
| F: 2 + ($29,000 / $62,000) = 2.47 years |
| G: 3 + ($26,000 / $122,000) = 3.21 years |
|
The
payback criterion implies accepting project F because it pays back
sooner than project G. Project G does not meet the minimum payback of
three years.
|
| (b) |
| The NPV for each project is: |
| F: NPV = – $139,000 + $58,000 / 1.11 + $52,000 / 1.112 + $62,000 / 1.113 + $57,000 / 1.114 |
| + $52,000 / 1.115 |
| NPV = $69,197.62 |
| G: NPV = – $209,000 + $38,000 / 1.11 + $53,000 / 1.112 + $92,000 / 1.113 |
| + $122,000 / 1.114 + $137,000 / 1.115 |
| NPV = $97,187.84 |
| The NPV criterion implies we should accept project G because project G has a higher NPV than project F. |
| (c) |
|
Even
though Project G does not meet the payback period of three years, it
does provide the largest increase in shareholder wealth, therefore,
choose Project G. Payback period should generally be ignored in this
situation.
|
| Calculator Solution: |
| Note: Intermediate answers are shown below as rounded, but the full answer was used to complete the calculation. |
| Project F | Project G | ||
|
CFo
| –$139,000 |
CFo
| –$209,000 |
|
C01
| $58,000 |
C01
| $38,000 |
|
F01
| 1 |
F01
| 1 |
|
C02
| $52,000 |
C02
| $53,000 |
|
F02
| 1 |
F02
| 1 |
|
C03
| $62,000 |
C03
| $92,000 |
|
F03
| 1 |
F03
| 1 |
| C04 | $57,000 | C04 | $122,000 |
| F04 | 1 | F04 | 1 |
| C05 | $52,000 | C05 | $137,000 |
| F05 | 1 | F05 | 1 |
| I = 11 | I = 11 | ||
| NPV CPT | NPV CPT | ||
| $69,197.62 | $97,187.84 | ||
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