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 |
||||||
1 | $40,000 | $130,000 | $84,000 | $208,000 | ||||||
2 | 40,000 | 130,000 | 64,000 | 176,000 | ||||||
3 | 40,000 | 130,000 | 32,000 | 124,000 | ||||||
4 | 40,000 | 130,000 | 14,000 | 85,000 | ||||||
5 | 40,000 | 130,000 | 6,000 | 57,000 | ||||||
Total | $200,000 | $650,000 | $200,000 | $650,000 |
Each project requires an investment of $400,000. 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 | |||||
Year | 6% | 10% | 12% | 15% | 20% |
1 | 0.943 | 0.909 | 0.893 | 0.870 | 0.833 |
2 | 0.890 | 0.826 | 0.797 | 0.756 | 0.694 |
3 | 0.840 | 0.751 | 0.712 | 0.658 | 0.579 |
4 | 0.792 | 0.683 | 0.636 | 0.572 | 0.482 |
5 | 0.747 | 0.621 | 0.567 | 0.497 | 0.402 |
6 | 0.705 | 0.564 | 0.507 | 0.432 | 0.335 |
7 | 0.665 | 0.513 | 0.452 | 0.376 | 0.279 |
8 | 0.627 | 0.467 | 0.404 | 0.327 | 0.233 |
9 | 0.592 | 0.424 | 0.361 | 0.284 | 0.194 |
10 | 0.558 | 0.386 | 0.322 | 0.247 | 0.162 |
Required:
1a. Compute the average rate of return for each investment. If required, round your answer to one decimal place.
Average Rate of Return | |
Warehouse | % |
Tracking Technology | % |
1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, use the minus sign to indicate a negative net present value.
Warehouse | Tracking Technology | |
Present value of net cash flow total | $ | $ |
Less amount to be invested | $ | $ |
Net present value | $ | $ |
2. The warehouse has a (larger or smaller) net present value as tracking technology cash flows occur (earlier, more evenly, or later) in time. Thus, if only one of the two projects can be accepted, the (tracking tech or warehouse) would be the more attractive.
Answer 1a | ||||||
Calculation of Average rate of return | ||||||
Warehouse | Tracking Technology | |||||
Total Income from operation for 5 years | $200,000.00 | $200,000.00 | ||||
/ Total No.of years | 5 | 5 | ||||
Average Return | $40,000.00 | $40,000.00 | ||||
/ Initial Investment | $400,000.00 | $400,000.00 | ||||
Average rate of return | 10% | 10% | ||||
Answer 1b | ||||||
Computation of present value of future cash flows | ||||||
Year | Discount Factor @ 10% | Warehouse | Tracking Technology | |||
Net Cash flow | Present Value | Net Cash flow | Present Value | |||
1 | 0.909 | $130,000.00 | $118,170.00 | $208,000.00 | $189,072.00 | |
2 | 0.826 | $130,000.00 | $107,380.00 | $176,000.00 | $145,376.00 | |
3 | 0.751 | $130,000.00 | $97,630.00 | $124,000.00 | $93,124.00 | |
4 | 0.683 | $130,000.00 | $88,790.00 | $85,000.00 | $58,055.00 | |
5 | 0.621 | $130,000.00 | $80,730.00 | $57,000.00 | $35,397.00 | |
Present value of future cash flows | $492,700.00 | $521,024.00 | ||||
Compute the net present value for each investment | ||||||
Warehouse | Tracking Technology | |||||
Present value of net cash flow total | $492,700.00 | $521,024.00 | ||||
Less : Amount to be invested | $400,000.00 | $400,000.00 | ||||
Net present value | $92,700.00 | $121,024.00 | ||||
Answer 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 tech would be the more attractive. | ||||||
Average Rate of Return Method, Net Present Value Method, and Analysis The capital investment committee of...
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