Considering three capital expenditure projects. If the minimum rate of return is 10%, which projects should be undertaken?Project            ...

Considering three capital expenditure projects. If the minimum rate of return is 10%, which projects should be undertaken?

Project             Investment                    Annual Income Life of Project

Alpha               $240,000                     $13,300                       6 years

Beta                   270,000                       19,000                       9 years

Gamma              288,000                       18,400                       8 years

The annual income is projected to remain constant over the life of each project. There will be no salvage value at the end of the projects and the company uses straight line depreciation.

Asked on by yacel0762

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justaguide | College Teacher | (Level 2) Distinguished Educator

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The initial investment for the three projects, the expected annual income and the life of the project is given.

The required rate of return is 10%. The viability of the projects can be determined by looking at the net present value in each case; if the NPV is positive the project is viable. As the rate of taxation is not provided, the effect of depreciation in reducing the payable taxes cannot be determined. Depreciation should not be considered as a cash inflow and as a result does not have any relevance here.

For project Alpha:

Initial investment or cash outflow is 240000

The sum of the discounted future earnings or future cash inflow is 13300/(1.1) + 13300/(1.1)^2 + ... + 13300/(1.1)^6 = 57924.96

As the net present value for the project is a negative value it is not viable.

Similarly for Project Beta, the NPV = 270000 - (19000/1.1 + 19000/(1.1)^2 +...+19000/(1.1)^9) = -160578.5

For project Gamma, the NPV  = 288000 - (18400/1.1 +18400/1.1^2+...+18400/(1.1)^8) = -189837.4

From the analysis of the cash flows for the projects none of them is viable for a 10% rate of return.

Sources:

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