Question

Average Rate of Return Method, Net Present Value Method, and Analysis for a service company

The capital investment committee of Arches Landscaping Company is considering two capital investments. The estimated income from operations and net cash flows from each investment are as follows:

	Front-End Loader					Greenhouse
Year	Income from Operations		Net Cash Flow			Income from Operations		Net Cash Flow
1	$45,600		$141,000			$96,000		$226,000
2	45,600		141,000			73,000		190,000
3	45,600		141,000			36,000		134,000
4	45,600		141,000			16,000		92,000
5	45,600		141,000			7,000		63,000
Total	$228,000		$705,000			$228,000		$705,000

Each project requires an investment of $480,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 10% for purposes of the net present value analysis.

Present Value of $1 at Compound Interest
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Required:

1a. Compute the average rate of return for each investment. If required, round your answer to one decimal place.

	Average Rate of Return
Front-End Loader	%
Greenhouse	%

1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, use the minus sign to indicate a negative net present value.

	Front-End Loader	Greenhouse
Present value of net cash flow	$	$
Amount to be invested	$	$
Net present value	$	$

Answer 1

Average net income	45600	=228000/5
Average Investment	240000	=480000/2
1a
	Average Rate of Return
Front-End Loader	19%	=45600/240000
Greenhouse	19%	=45600/240000
1b
	Front-End Loader	Greenhouse
Present value of net cash flow	534390	564967
Amount to be invested	480000	480000
Net present value	54390	84967
Workings:
	Front-End Loader			Greenhouse
	Cash flows	PV factor 10%	Present value	Cash flows	PV factor 10%	Present value
1	141000	0.909	128169	226000	0.909	205434
2	141000	0.826	116466	190000	0.826	156940
3	141000	0.751	105891	134000	0.751	100634
4	141000	0.683	96303	92000	0.683	62836
5	141000	0.621	87561	63000	0.621	39123
		Total	534390		Total	564967