Question

1. HomeGrown Company is a chain of grocery stores that are similar to indoor farmer's markets, providing fresh, local produce, meats, and dairy products to consumers in urban areas. HomeGrown is considering opening several stores in a new city, and has proposals from three contractors (Alpha, Beta, and Gamma companies) who would like to provide buildings for the new stores.

   The amount of expected revenue from the stores will depend on the design of the contractor. For example, if HomeGrown decides on a more open floor plan, with less shelf space for products, revenue would be lower overall. However, if HomeGrown decides on a very crowded floor plan, it may lose customers who appreciate a more open feel.

   As the project manager for HomeGrown, you are responsible for deciding which if any of the proposals to accept. HomeGrown's minimum acceptable rate of return is 20%. You receive the following data from the three contractors:

   Proposal	Type of Floor Plan	Initial Cost if Selected	Residual Value
   Alpha	Very open, like an indoor farmer’s market	$1,472,000	$0.00
   Beta	Standard grocery shelving and layout, minimal aisle space	5,678,900	0.00
   Gamma	Mix of open areas and shelving areas	2,125,560	0.00

   You have computed estimates of annual cash flows and average annual income from customers for each of the three contractors' plans. You believe that the annual cash flows will be equal for each of the 10 years for which you are preparing your capital investment analysis. Your conclusions are presented in the following table.

   Proposal	Estimated Average Annual Income (after depreciation)	Estimated Average Annual Cash Flow
   Alpha	$302,054	$351,145
   Beta	272,019	461,411
   Gamma	527,245	592,819

   Method Comparison

   Compare methods of capital investment analysis in the following table to begin your evaluation of the three capital investment proposals Alpha, Beta, and Gamma. You decide to compare four methods: the average rate of return, cash payback period, net present value, and internal rate of return methods.

   	Average Rate of Return Method	Cash Payback Method	Net Present Value Method	Internal Rate of Return Method
   Considers the time value of money
   Does not consider the time value of money
   Easy to compute
   Not as easy to compute
   Directly considers expected cash flows
   Directly considers timing of expected cash flows
   Assumes cash flows can be reinvested at minimum desired rate of return
   Can be used to rank proposals even if project lives are not the same

   Average Rate of Return

   You begin by trying to eliminate any proposals that are not yielding the company’s minimum required rate of return of 20%. Complete the following table, and decide whether Alpha, Beta, and/or Gamma should be eliminated because the average rate of return of their project is less than the company's minimum required rate of return.

   Complete the following table. Enter the average rates of return as percentages rounded to two decimal places.

   Proposal	Estimated Average Annual Income	Average Investment	Average Rate of Return	Accept or Reject
   Alpha	$	$	%
   Beta
   Gamma

   Cash Payback Method

   You’ve decided to confirm your results from the average rate of return by using the cash payback method.

   Using the following table, compute the cash payback period of each investment. If required, round the number of years in the cash payback period to a whole number.

   Proposal	Initial Cost	Annual Net Cash Inflow	Cash Payback Period in Years
   Alpha	$	$
   Beta
   Gamma

   Net Present Value

   Even though you’re fairly certain that your evaluation and elimination is correct, you would like to compare the three proposals using the net present value method, and get some data about the internal rate of return of the proposals, each of which are expected to generate their respective annual net cash inflows for a period of 10 years.

   Compute the net present value of each proposal. You may need the following partial table of factors for present value of an annuity of $1. Round the present value of annual net cash flows to the nearest dollar. If your answer is zero enter "0". For the net present value, if required, use the minus sign (-) to indicate a negative amount.

   Present Value of an Annuity of $1 at Compound Interest (Partial Table)
   Year	10%	20%
   1	0.909	0.833
   5	3.791	2.991
   10	6.145	4.192

   	Alpha	Beta	Gamma
   Annual net cash flow	$	$	$
   Present value factor
   Present value of annual net cash flows	$	$	$
   Amount to be invested
   Net present value	$	$	$

   Final Questions

   After reviewing all your data, answer the following questions (1)-(3).

   1. What can you say about each proposal?

   Proposal	Internal Rate of Return
   Alpha
   Beta
   Gamma

   2. What can you say about these proposals?

   a. HomeGrown would be breaking even (i.e., profit = 0) if Alpha’s proposal is chosen.

   b. Only Gamma’s proposal is yielding more than HomeGrown’s minimum desired rate of return.

   c. Gamma’s proposal is the only proposal that would be acceptable to HomeGrown.

   3. Which proposal is the best choice for HomeGrown given the data collected?

Answer 1

Proposal Investment Alpha $ 14,72,000.00 Beta $ 60,79,300.00 Gamma $ 23,25,760.00 Minimum acceptable rate of return 20% 1) Average Rate of return Estimated Average Investment/2 Proposal Annual Income(a) Average Investment(b) Average Rate of return(a/b) Alpha $ 2,91,014.00 $ 7,36,000.00 39.54% Beta $ 2,91,198.00 $ 30,39,650.00 9.58% Gamma$ 5,71,090.00 $ 11,62,880.00 49.11% Accept of reject Accept Reject Accept 2) Pay back period Proposal Alpha Beta Cash payback period in yrs 4.192 $ $ $ Initial cost 14,72,000.00 $ 60,79,300.00 $ 23,25,760.00 $ Annual cash flow 3,51,145.00 5,09,141.00 6,48,654.00 11.940 Gamma 3.586

3) NPV $ Annual net cash flow Times present value factor Equals present value of annual net cash flow Less: Amount to be invested Equals Net present value Alpha 3,51,145.00 $ 4.192 14,71,999.84 $ 14,72,000.00 $ (0.16) $ Gamma 6,48,654.00 4.192 27,19,157.57 23,25,760.00 3,93,397.57 Beta 5,09,141.00 $ 4.192 21,34,319.07 $ 60,79,300.00 $ (39,44,980.93) $ $ $ $ 4) Let rate be 10% $ Annual net cash flow Times present value factor Equals present value of annual net cash flow Less: Amount to be invested Equals Net present value Alpha 3,51,145.00 $ 6.145 21,57,786.03 $ 14,72,000.00 $ 6,85,786.03 $ Beta 5,09,141.00 $ 6.145 31,28,671.45$ 60,79,300.00 $ (29,50,628.56) $ Gamma 6,48,654.00 6.145 39,85,978.83 23,25,760.00 16,60,218.83 $ $ $ Proposal Alpha Beta Internal rate of return <20% <20% > 20% Gamma 5) Gamma is the best choice for home grown given the data collected