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27 January, 11:53

Savanna Company is considering two capital investment proposals. Relevant data on each project are as follows: Project Red Project BlueCapital investment $440,000 $640,000Annual net income $25,000 $60,000Estimated useful life 8 years 8 yearsDepreciation is computed by the straight-line method with no salvage value. Savanna requires an 8% rate of return on all new investments. The present value of 1 for 8 periods at 8% is. 540 and the present value of an annuity of 1 for 8 periods is 5.747. (a) Compute the cash payback period for each project. (b) Compute the net present value for each project. (c) Compute the annual rate of return for each project. (d) Which project should Savanna select?

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  1. 27 January, 13:31
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    (a) Cash payback period:

    Project Red = 5.5 years

    Project blue = 4.6 years

    (b) Net present value for project Red = $19,760

    Net present value for project Blue = $164,580

    (c) Annual rate of return:

    Project Red = 11.36%

    Project Blue = 18.75%

    (d) Project Blue

    Explanation:

    Given Data;

    Project Blue Capital investment = $640,000

    Project Red Capital investment = $440,000

    Project Red Annual Net income = $ 25,000.

    Project Blue Annual Net income = $ 60,000

    Annual depreciation Project Red = (440000/8)

    = 55,000

    Annual depreciation Project Blue = (640000/8)

    = 80,000

    Annual cash inflow project A = $ 80,000

    Annual cash inflow project B = $140,000

    (a)

    Cash payback period = Initial investment/cash flow per period

    Project Red = 440000 / 80000

    = 5.5 years

    Project blue = 640000 / 140000

    = 4.6 years

    (b)

    Project Red Present value of cash inflows = 80000 * 5.747

    = $459,760

    Project Blue Present value of cash inflows = 140000*5.747

    = 804580

    Net present value for project Red = $459,760 - $440,000

    = $19,760

    Net present value for project Blue = 804580 - $640,000

    =$164,580

    (c) Annual rate of return:

    Project Red = $25,000 / ($440000) / 2

    =11.36%

    Project Blue = $60000 / (640000/2)

    =18.75%

    (d) Savanna should select Project Blue because it has a higher positive NPV and a higher annual rate of return. AND Project Blue has early cash back period also
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