# Incremental Analysis and Capital Budgeting

U3 Company is considering three long-term capital investment proposals. Each investment has a useful life of 5 years. Relevant data on each project are as follows.

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(a) Project Bono \$160,000 / (\$14,000 + \$32,000) = 3.48 years

 Project Edge Year Cash Flow Cumulative Cash Flow 1 2 3 4 5 \$53,000 (\$18,000 + \$35,000) \$52,000 (\$17,000 + \$35,000) \$51,000 (\$16,000 + \$35,000) \$47,000 (\$12,000 + \$35,000) \$44,000 (\$ 9,000 + \$35,000) \$ 53,000 \$105,000 \$156,000 \$203,000 \$247,000

Cash payback period 3.40 years

\$175,000 - \$156,000 = \$19,000

\$19,000 / \$47,000 = .40

 Project Clayton Year Cash Flow Cumulative Cash Flow 1 2 3 4 5 \$67,000 (\$27,000 + \$40,000) \$63,000 (\$23,000 + \$40,000) \$61,000 (\$21,000 + \$40,000) \$53,000 (\$13,000 + \$40,000) \$52,000 (\$12,000 + \$40,000) \$ 67,000 \$130,000 \$191,000 \$244,000 \$296,000

Cash payback period 3.17 years

\$200,000 - \$191,000 = \$9,000

\$9,000 / \$53,000 = .17

(b) Project Bono

 Item Amount Years PV Factor Present Value Net annual cash flows Less: Capital investment Negative net present value \$46,000 1-5 3.35216 \$154,199 160,000 \$ (5,801)

 Project Edge Project Clayton Year Discount Factor Cash Flow PV Cash Flow PV 1 2 3 4 5 Total .86957 .75614 .65752 .57175 .49718 \$ 53,000 52,000 51,000 47,000 44,000 \$247,000 \$ 46,087 39,319 33,534 26,872 21,876 167,688 175,000    \$ (7,312) \$ 67,000 63,000 61,000 53,000 52,000 \$296,000 \$ 58,261 47,637 40,109 30,303 25,853 202,163 200,000    \$ 2,163 Less: Capital investment Positive (negative) net present value

(c) Project Bono = \$14,000 / [(\$160,000 + \$0) / 2] = 17.5%.

Project Edge = \$14,400 / [(\$175,000 + \$0) / 2] = 16.5%.

Project Clayton = \$19,200 / [(\$200,000 + \$0) / 2] = 19.2%.

 (d) Project Cash Payback Net Present Value Annual Rate of Return Bono Edge Clayton 3 2 1 2 3 1 2 3 1

The best project is Clayton.

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