Which of the following projects is acceptable given the required criteria for being so:Considering three new projects, each requiring an initial equipment investment of $21,000.  Each project will...

Which of the following projects is acceptable given the required criteria for being so:

Considering three new projects, each requiring an initial equipment investment of $21,000.  Each project will last for 3 years and produce the following cash flows:

Year                 Project 1          Project 2          Project 3

1                      $ 7,000            $ 9,500            $13,000

2                         9,000               9,500              10,000

3                      15,000               9,500              11,000

Total                $31,000           $28,500           $34,000

The equipment has no salvage value and SSA uses straight-line depreciation.  No project will be accepted with a payback period over 2 years.  Their minimum required rate of return is 12%.

Asked on by yacel0762

1 Answer | Add Yours

justaguide's profile pic

justaguide | College Teacher | (Level 2) Distinguished Educator

Posted on

From the information provided about the projects it is seen that each of them has a initial cash outflow of $21000. The minimum required rate of return is 12% and no project with a payback period over 2 years would be accepted.

It is seen that the returns of project 1 over 2 years is 16000 and for project 2 it is 19000 even when the rate of return is taken to be 0. It is evident that these projects are not acceptable. For project 3, the returns over the first 2 years if they are not discounted is 23000 which is higher than the initial outflow. But on discounting each of them by 12% the inflow is 13000/1.12 + 10000/1.12^2 = 19579.08 which is lower than the initial outflow. The payback period is therefore greater than 2 years.

This shows that none of the three projects can be accepted as they do not provide a payback period of 2 years for a required rate of return of 12%.

Sources:

We’ve answered 318,923 questions. We can answer yours, too.

Ask a question