Question

Hearne 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 $5,800,000. It would generate $1,036,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,228,000. Project 2: Purchase Patent for New Product The patent would cost $4,065,000, which would be fully amortized over five years. Production of this product would generate $894,300 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 $210,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $6,900. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $1,155,000 of additional net income per year.

Answer 1

project 1 - Initial investment - $ 5800000 Average annual med cash flow = $1036000 $580000 depreciation S&0000 $122800 $122.8000 $57 SOD project 2! Initial investment = $4065000 Avesage annual net income = $894300 Amortisation cost 4065000 48150m project 3. der Initial investment = $210000 per tuck Average annual net income = $1155000 Salvage value = $6900 pą tuck useful life = 10 years. 210000 - 690 = $20 310 per truck 1 computation of accounting Sate of return ARR = Average annual net income Antal investment project ! ARE Avesage annual net income Initial investment Average annual net cash flow - depreciatia Initial investment $1036000 - $571500 $5800000 = 8.01% COR) 0.0 801
​​​​​​
project 2- ARR = $894300 $4065000 = 0.22 il. 22º% project 3 :- 1155000 $1155000 ARR - - $210000 x 25 5250000 = 0.22 il 2216 Accounting Rate & Return 0.0801 8.01% 0.22 0.22 pooject 1 & project 2 I project 3 224 224 2. computation of payback period. payback pesiod - Initial capital investment Annual net cash to inflow. project 1 : payback period $ 5800000 $1036000 p.a. = 5.6 years

project 2: payback pesiod = NOC $4065000 $894300* + $813000 $4065000 $1707300 2.38 years Amortisation cost is added back to net income to Calealate eash 1. inflow project 3! payback period = $210 000 X 25 $1155000 + $ 20210 x 25 depreciation cast is adeled back I to net income $525000 $1155000 + $507750 $5250000 $1662750 = 3.16 years

fotxarosta 7 (988ox saxaobott 1619 Xovossi ) = = toofaed to AS +08088753 S880 1 719 - fe pofect sexoooon sexaoba moss! 787870572$ = d enored - ($894000 +$81300 ) x 3,789 - $4065000 1 NPV - 002962 $ = m100085$ - 827ls$2Sb&css$ = project 1 - y = $1036000 X 5,332 + $1228000X0,466 - $5201 2 po ndiv

Nov a project 3 = Annual cash flow = $1155000 + $20310 825 = $1662750 Initial investment = $21000 X25 - $5250000 horonarn ($1662750 % 6,141)+ ($6900X25 X0.385) NPV of project 3 = 1 - $5250000 = $10210948+ $66412 - $5250000 = $5027360/-

4. computation of profitability Index profitability index = present value of cash inflow Initial cash onllay project 1 $1036000 X 5,332 + $1228000 X0.466 = - $580000 = 2.0034 moject 2 - ($894000 + $ 813000) * 3.789 - = 1.59 4065000 project 3 = ($1662750 X 6,141)+ $6900 X 25 X0.385) -=1.96 $5250000

ncremental Cash Fl- jn Rank mofitability "Index I project 1 2.0034 project 2 1:59 project3/ 1,96
the projects are ranked on the basis of profitability index...if it were ranked on basis of any other tool then the decision will differ from above.