Question

average rate of Return Method, Net Present Value Method, and Analysis The capital investment committee of Cross Continent Trucking Inc. is considering two capital investments. The estimated income from operations and net cash flows from each investment are as follows: Warehouse Tracking Technology Income from Net Cash Income from Year Net Cash Operations Flow Operations Flow $44,000 $143,000 $92,000 $229,000 44,000 143,000 70,000 193,000 44,000 143,000 35,000 136,000 44,000 143,000 15,000 93,000 44,000 143,000 8,000 64,000 Total $220.000 $715,000 $220.000 $715,000 Each project requires an investment of $440,000. 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 6% 10% 12% 15% 20% Year 1 0.909 0.893 0.870 0.833 0.943 0.890 0.840 0.792 0.747 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.797 0.712 0.636 0.567 0.507 0.452 0.404 0.361 0.756 0.658 0.572 0.497 0.432 0.376 0.327 0.284 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 6 0.705 0.665 0.627 0.592

Answer 1

Solution 1a:

Average rate of return = Average annual income / Average investment

Average annual income:

Warehouse = $220,000 / 5 = $44,000

Tracking technology = $220,000 / 5 = $44,000

Average investment:

Warehouse = (440,000 + 0) / 2 = 220,000

Tracking technology =   440,000 + 0) / 2 = 220,000

Average rate of return:

Warehouse = $44,000 / $220,000 = 20%

Tracking technology = $44,000 / $220,000 = 20%

Solution 1b:

Computation of NPV
			Warehouse		Tracking Technology
Particulars	Period	PV Factor	Amount	Present Value	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$440,000	$440,000	$440,000	$440,000
Present Value of Cash outflows (A)				$440,000		$440,000
Cash Inflows
Year 1	1	0.909	$143,000	$129,987	$229,000	$208,161
Year 2	2	0.826	$143,000	$118,118	$193,000	$159,418
Year 3	3	0.751	$143,000	$107,393	$136,000	$102,136
Year 4	4	0.683	$143,000	$97,669	$93,000	$63,519
Year 5	5	0.621	$143,000	$88,803	$64,000	$39,744
Present Value of Cash Inflows (B)				$541,970		$572,978
Net Present Value (NPV) (B-A)				$101,970		$132,978

Solution 2:

The warehouse has a smaller net present value as tracking technology cash flows occur earlier in time. Thus if only one of the two project can be accepted, the tracking technology would be the more attractive.