Andrews Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year. The capital budget is limited to $6,000,000 for the year. Lori Bart, staff analyst at Andrews, is preparing an analysis of the three projects under consideration by Corey Andrews, the companyâs owner.
Required: 1. Because the companyâs cash is limited, Andrews thinks the payback method should be used to choose between the capital budgeting projects. a. What are the benefits and limitations of using the payback method to choose between projects? b. Calculate the payback period for each of the three projects. Ignore income taxes. Using the payback method, which projects should Andrews choose? 2. Bart thinks that projects should be selected based on their NPVs. Assume all cash flows occur at the end of the year except for initial investment amounts. Calculate the NPV for each project. Ignore income taxes. 3. Which projects, if any, would you recommend funding? Briefly explain why.
A В D Project A Project B Project C 1 2 Projected cash outflow 3 Net initial investment $3,000,000 $1,500,000 $4,000,000 5 Projected cash inflows 6 Year 1 7 Year 2 8 Year 3 9 Year 4 $ 400,000 $1,000,000 1,000,000 1,000,000 $2,000,000 2,000,000 900,000 800,000 200,000 1,000,000 100,000 10 11 Required rate of return 10% 10% 10%