Question

RozzisRozzis

Construction is analyzing its capital expenditure proposals forthe purchase of equipment in the coming year. The capital budget islimited to

$ 5 comma 000 comma 000$5,000,000

for the year.

LindaLinda

BensonBenson?,

staff analyst at

RozzisRozzis?,

is preparing an analysis of the three projects underconsideration by

ChesterChester

RozzisRozzis?,

the? company's owner.

Requirement 1. Because the? company's cash is?limited,

RozzisRozzis

thinks the payback method should be used to choose between thecapital budgeting projects.

a. What are the benefits and limitations ofusing the payback method to choose between? projects?

Benefits of the payback? method:

A.

Easy to understand and captures uncertainty about expected cashflows in later years of a project

Your answer is correct.

B.

Indicates whether or not the project will earn the? company'sminimum required rate of return

C.

Utilizes the time value of money and computes each? project'sunique rate of return

D.

All of the above

Limitations of the payback? method:

A.

Cannot be used when? management's required rate of return variesfrom one period to the next.

B.

Cannot be used for projects with unequal periodic cash flows

C.

Fails to incorporate the time value of money and does notconsider a? project's cash flows after the payback period

D.

All of the above

Data Table:

Project A

Project B

Project C

Projected cash outflow

Net initial investment

$3,000,000

$2,100,000

$3,000,000

Projected cash inflows

Year 1

$1,200,000

$1,200,000

$1,700,000

Year 2

1,200,000

600,000

1,700,000

Year 3

1,200,000

500,000

200,000

Year 4

1,200,000

100,000

Required rate of return

8%

8%

8%

Requirements:

1.	Because the? company's cash is? limited, RozzisRozzis thinks the payback method should be used to choose between thecapital budgeting projects.
	a.	What are the benefits and limitations of using the paybackmethod to choose between? projects?
	b.	Calculate the payback period for each of the three projects. Ignoreincome taxes. Using the payback? method, which projects should RozzisRozzis ?choose?
2.	BensonBenson thinks that projects should be selected based on their NPVs. Assumeall cash flows occur at the end of the year except for initialinvestment amounts. Calculate the NPV for each project. Ignoreincome taxes.
3.	Which? projects, if? any, would you recommend? funding? Brieflyexplain why.