McGloire Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year. The capital budget is limited to $5,000,000 for the year. Lori Alleyne, staff analyst at McGloire’s, is preparing an analysis of the three projects under consideration by Joyanne McGloire, the company’s owner. A B C D 1 Project A Project B Project C 2 Projected cash outflow 3 Net initial investment $3 000 000 $1 500 000 $4 000 000 4 5 Projected cash inflows 6 Year 1 $1 000 000 $400 000 $2 000 000 7 Year 2 1 000 000 900 000 2 000 000 8 Year 3 1 000 000 800 000 200 000 9 Year 4 1 000 000 100 000 10 11 Required rate of return 10% 10% 10% 1. Because the company’s cash is limited, McGloire thinks the payback method should be used to choose between the capital budgeting projects. a. List two benefits and two 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 McGloire choose and why? 2. Alleyne 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. Using both Payback and NPV results, which projects, if any, would you recommend McGloire should fund? Justify your answer and include a critical assessment of two nonfinancial qualitative factors that could affect the investment.
McGloire Construction is analyzing its capital expenditure proposals for the
purchase of equipment in the coming year. The capital budget is limited to $5,000,000 for the
year. Lori Alleyne, staff analyst at McGloire’s, is preparing an analysis of the three projects
under consideration by Joyanne McGloire, the company’s owner.
| A | B | C | D | |
| 1 | Project A | Project B | Project C | |
| 2 | Projected |
|||
| 3 | Net initial investment | $3 000 000 | $1 500 000 | $4 000 000 |
| 4 | ||||
| 5 | Projected |
|||
| 6 | Year 1 | $1 000 000 | $400 000 | $2 000 000 |
| 7 | Year 2 | 1 000 000 | 900 000 | 2 000 000 |
| 8 | Year 3 | 1 000 000 | 800 000 | 200 000 |
| 9 | Year 4 | 1 000 000 | 100 000 | |
| 10 | ||||
| 11 | Required |
10% | 10% | 10% |
1. Because the company’s cash is limited, McGloire thinks the payback method
should be used to choose between the capital budgeting projects.
a. List two benefits and two 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
McGloire choose and why?
2. Alleyne 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
3. Using both Payback and NPV results, which projects, if any, would you
recommend McGloire should fund? Justify your answer and include a critical
assessment of two nonfinancial qualitative factors that could affect the investment.
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