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 $5,100,000. It would generate $910,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,060,000. Project 2: Purchase Patent for New Product The patent would cost $3,575,000, which would be fully amortized over five years. Production of this product would generate $536,250 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 $140,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,500. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $525,000 of additional net income per year. Required: 1. Determine each project's accounting rate of return. (Round your answers to 2 decimal places.) 2. Determine each project's payback period. (Round your answers to 2 decimal places.) 3. Using a discount rate of 10 percent, calculate the net present value of each project. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Round your intermediate calculations to 4 decimal places and final answers to 2 decimal places.) 4. Determine the profitability index of each project and prioritize the projects for Hearne. (Round your intermediate calculations to 2 decimal places. Round your final answers to 4 decimal places.)

Answer 1

		(IN $)
	NET CASH FLOW EACH YEAR
	PROJECT 1 (LIFE 8 YEARS)
	NET CAH FLOW EACH YEAR	910000
	PROJECT 2 (LIFE 5 YEARS)
	NET INCOME EACH YEAR	536250
	ADD: AMORTISATION	715000
	3575000
	5 YEARS
		1251250
	PROJECT 3 (LIFE 10 YEARS)
	NET INCOME EACH YEAR	525000
	ADD: DEPRECIATION	336250
	(140000*25) - (5500*25)
	10 YEARS
		861250
	PAYBACK PERIOD	TOTAL INITIAL CAPITAL INVESTMENT
		ANNUAL EXPECTED CASH FLOW
		PROJECT 1	PROJECT 2	PROJECT 3
	a. INITIAL INVESTMENT	5100000	3575000	3500000
	b. ANNUAL EXPECTED CASH FLOW	910000	1251250	861250
	PAYBACK PERIOD (a / b)	5.60	2.86	4.06	YEARS
	NET PRESENT VALUE	= PRESENT VALUE OF CASH INFLOW (-) PRESENT VALUE OF CASH OUTFLOW
	PARTICULARS	YEAR			NET CASH FLOW			PVIF @10%	DISCOUNTED CASH FLOW
		P 1	P 2	P 3	P 1	P 2	P 3		P 1	P 2	P 3
	CASH OUT FLOW (a)
	INITIAL INVESTMENT	0	0	0	5100000	3575000	3500000	1	5100000	3575000	3500000
	CASH IN FLOW
	ANNUAL CASH INFLOW	1 TO 8			910000			5.3349	4854759
			1 TO 5			1251250		3.7907		4743113
				1 TO 10			861250	6.1445			5291951
	SALVAGE VALUE	8			1060000			0.4665	494490
				10			137500	0.3855			53006.25
	PV OF CASH IN FLOW (b)								5349249	4743113	5344957
	NPV (b - a)								249249	1168113	1844957
	PROBABILITY INDEX	= PRESENT VALUE OF CASH INFLOW / PRESENT VALUE OF CASH OUTFLOW
	PI (b /a)								1.05	1.33	1.53