Question

Heame Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them. Assume straight line depreciation method is used. Project 1: Retooling Manufacturing Facility This project would require an initial investment of $5,300,000. It would generate $946,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,108,000 Project 2: Purchase Patent for New Product The patent would cost $3,715,000, which would be fully amortized over five years. Production of this product would generate $631,550 additional annual net income for Hearne. Project 3: Purchase a New Fleet of Delivery Trucks Hearne could purchase 25 new delivery trucks at a cost of $160,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,900. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $680,000 of additional net income per year. Required: 1. Determine each project's accounting rate of return. (Round your answers to 2 decimal places.) Accounting Rate of Return Project 1 Project 2 Project 3 2. Determine each project's payback period. (Round your answers to 2 decimal places.) Payback Period Years Project 1 Project 2 Project 3 Years Years 3. Using a discount rate of 10 percent, calculate the net present value of each project. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Round your intermediate calculations to 4 decimal places and final answers to 2 decimal places.) Net Present Value Project 1 Project 2 Project 3

Answer 1

	Project 1	Project 2	Project 3
Initial Investment (A)	53,00,000	37,15,000	40,00,000
Annual net Cash Inflow (B)	9,46,000	6,31,550	6,80,000
Salvage Value of Machinery (C)	11,08,000	-	1,47,500
Useful Life	8	5	10
Annual Depreciation Expense (D)	5,24,000	7,43,000	3,85,250
Net Income / (Loss) (E) = (B)- (D)	4,22,000	(1,11,450)	2,94,750
Accounting Rate of Return = (E) / (A) * 100	7.96%	-3.00%	7.37%
Payback Period (Years)= (A) / (B)	5.60	5.88	5.88
PVIFA @ 10% for 8, 5 & 10 Years Respectively	5.3349	3.7908	6.1446
PV of Annual Cash Inflows (F)	50,46,840.18	23,94,071.38	41,78,305.63
PV @ 10% for 8, 5 & 10 Years Respectively	0.4665	0.6209	0.3855
PV of Salvage Value (G)	5,16,890.18	-	56,867.64
Total PV of Cash Flows (H) = (F)+(G)	55,63,730.36	23,94,071.38	42,35,173.27
Net Present Value (H) - (A)	2,63,730.36	(13,20,928.62)	2,35,173.27