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 $5,250,000. It
would generate $937,000 in additional net cash flow each year. The
new machinery has a useful life of eight years and a salvage value
of $1,096,000.
Project 2: Purchase Patent for New Product
The patent would cost $3,680,000, which would be fully amortized
over five years. Production of this product would generate $607,200
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 $155,000
each. The fleet would have a useful life of 10 years, and each
truck would have a salvage value of $5,800. Purchasing the fleet
would allow Hearne to expand its customer territory resulting in
$639,400 of additional net income per year.
Required:
1. Determine each project's accounting rate of return.
(Round your answers to 2 decimal places.)
projects
1
2
3
2. Determine each project's payback period.
(Round your answers to 2 decimal places.)
projects
1
2
3
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.)
Projects
1
2
3
Solution 1:
Accounting rate of return = Average annual income / Average investment
Average annual income:
Project 1 = $937,000 - ($5,250,000 - $1,096,000)/8 = $417,750
Project 2 = $607,200
Project 3 = $639,400
Average investment: (Cost + Salvage value)/2
Project 1 = ($5,250,000 + $1,096,000)/2 = $3,173,000
Project 2 = $3,680,000/2 = $1,840,000
Project 3 = (155000*25 + 5800*25)/2 = $2,010,000
Accounting rate of return:
Project 1 = $417,750 / $3,173,000 = 13.17%
Project 2 = $607,200 / $1,840,000 = 33%
Project 3 = $639,400 / $2,010,000 = 31.81%
Solution 2:
Payback period = Initial investment / Annual cash inflows
Annual cash inflows:
Project 1 = $937,000
Project 2 = $607,200 + ($3,680,000/5) = $1,343,200
Project 3 = $639,400 + ($3,875,000 - $145,000)/10 = $1,012,400
Payback period:
Project 1 = $5,250,000 / $937,000 = 5.60 years
Project 2 = $3,680,000 / $1,343,200 = 2.74 years
Project 3 = $3,875,000 / $1,012,400 = 3.83 years
Solution 3:
Computation of NPV - Hearne Company | ||||||||||||
Project 1 | Project 2 | Project 3 | ||||||||||
Particulars | Period | PV Factor | Amount | Present Value | Period | PV Factor | Amount | Present Value | Period | PV Factor | Amount | Present Value |
Cash outflows: | ||||||||||||
Cost of Equipment | 0 | 1 | $5,250,000.00 | $5,250,000.00 | 0 | 1 | $3,680,000.00 | $3,680,000.00 | 0 | 1 | $3,875,000.00 | $3,875,000.00 |
Present Value of Cash outflows (A) | $5,250,000.00 | $3,680,000.00 | $3,875,000.00 | |||||||||
Cash Inflows | ||||||||||||
Annual cash flows | 1-8 | 5.3349 | $937,000.00 | $4,998,801.30 | 1-5 | 3.7908 | $1,343,200.00 | $5,091,802.56 | 1-10 | 6.1446 | $1,012,400.00 | $6,220,793.04 |
Salvage Value | 8 | 0.4665 | $1,096,000.00 | $511,284.00 | 5 | 0.6209 | $0.00 | $0.00 | 10 | 0.3855 | $145,000.00 | $55,897.50 |
Present Value of Cash Inflows (B) | $5,510,085.30 | $5,091,802.56 | $6,276,690.54 | |||||||||
Net Present Value (NPV) (B-A) | $260,085.30 | $1,411,802.56 | $2,401,690.54 |
Hearne Company has a number of potential capital investments. Because these projects vary in natu...
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 $5,250,000. It would generate $937,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,096,000. Project 2: Purchase Patent...
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