Question

Presented is information pertaining to the cash flows of three mutually exclusive investment proposals: Proposal X Proposal Y Proposal z $92,000 $92,000 $92,000 Initial investment Cash flow from operations Year 1 92,000 90,000 2,000 47,500 Year 2 Year 3 Disinvestment Life (years) 46,000 46,000 47,500 0 3 years 0 1 year 3 years (a) Select the best investment proposal using the payback period, the accounting rate of return on initial investment, and the net present value criteria. Assume that the organization's cost of capital is 14 percent. • Round accounting rate of return four decimal places. • Round net present value to the nearest whole number. • Use negative signs with your answers, when appropriate. Best proposal Proposal X 2v Proposal Y 2 Payback period (years) Accounting rate of return Net present value Proposal Z - 12 OXY (11,298) X 0x 0 x 0 x 15,788

Answer 1

Answer:

         I.            Calculation of Payback Period:

Step 1: We must pick the year in which the outflows have become Zero or positive:

Year	Proposal X		Proposal Y		Proposal Z
	Cash Flow	Cumulative Cash Flow	Cash Flow	Cumulative Cash Flow	Cash Flow	Cumulative Cash Flow
0	(92,000.00)	(92,000.00)	(92,000.00)	(92,000.00)	(92,000.00)	(92,000.00)
1	90,000.00	(2,000.00)	46,000.00	(46,000.00)	92,000.00	-
2	2,000.00	-	46,000.00	-	-	-
3	47,500.00	47,500.00	47,500.00	47,500.00	-	-

Step 2:

Particulars	Proposal X	Proposal Y	Proposal Z
Payback Period	2 years	2 years	1 Year

        II.            Calculation of accounting rate of return:

Formula= Average Profits or Inflows /Average Investment*100

Particulars	Proposal X	Proposal Y	Proposal Z
A.       Average Investment	92,000	92,000	92,000
B.       Average Profits or Inflows	= (90000+2000+47500)/3 = 46,500	= (46000+46000+47500)/3 = 46,500	= 92,000/1
C.        Accounting Rate of Return (B/A)	50.5435%	50.5435%	100.0000%

      III.            Calculation of Net Present Value:

Formula= Cash Flow* Present Value factor

Year	Proposal X			Proposal Y			Proposal Z
	Cash Flow	Present Value Factor	Present Value	Cash Flow	Present Value Factor	Present Value	Cash Flow	Present Value Factor	Present Value
0	(92,000)	1.000	(92,000)	(92,000)	1.000	(92,000)	(92,000)	1.000	(92,000)
1	90,000	0.877	78,947	46,000	0.877	40,351	92,000	0.877	80,701
2	2,000	0.769	1,539	46,000	0.769	35,395	-	0.769	-
3	47,500	0.675	32,061	47,500	0.675	32,061	-	0.675	-
		Total	20,547		Total	15,807		Total	(11,299)

Hence, Proposal X is the best option to choose with highest Net Present Value ($20,547) and Payback period of 2 years & ARR of 50.5435% same as Project Y.