Question

Average Rate of Return Method, Net Present Value Method, and Analysis The capital investment committee of Ellis Transport and Storage Inc. is considering two investment projects. The estimated income from operations and net cash flows from each investment are as follows: Warehouse Tracking Technology Year Income from Operations Net Cash Flow Income from Operations Net Cash Flow $53,200 $167,000 $267,000 53,200 167,000 225,000 $112,000 85,000 43,000 19,000 53,200 167,000 159,000 53,200 167,000 109,000 53,200 167,000 7,000 75,000 Total $266,000 $835,000 $266,000 $835,000 Each project requires an investment of $560,000. 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. Year 1 Present Value of $1 at Compound Interest 6% 10% 12% 15% 20% 0.943 0.9090.893 0.870 0.833 0.890 0.826 0.797 0.756 0.694 0.840 0.751 0.712 0.658 0.579 0.792 0.683 0.636 0.572 0.482 4

Answer 1

Average Annual net income	53200	=266000/5
Average Investment	280000	=560000/2
1a
	Average Rate of Return
Warehouse	19%	=53200/280000
Tracking Technology	19%	=53200/280000
1b
	Warehouse	Tracking Technology
Present value of net cash flow total	632930	668984
Less amount to be invested	560000	560000
Net present value	72930	108984
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 projects can be accepted, the Tracking Technology would be the more attractive.
Workings:
	Warehouse			Tracking Technology
Year	Cash flows	PV factor 10%	Present value	Cash flows	PV factor 10%	Present value
1	167000	0.909	151803	267000	0.909	242703
2	167000	0.826	137942	225000	0.826	185850
3	167000	0.751	125417	159000	0.751	119409
4	167000	0.683	114061	109000	0.683	74447
5	167000	0.621	103707	75000	0.621	46575
		Total	632930		Total	668984