Question

Capital Rationing Decision for a Service Company Involving Four Proposals

Renaissance Capital Group is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated operating income, and net cash flow for each proposal are as follows:

	Investment	Year		Operating Income		Net Cash Flow
Proposal A:	$680,000	1		$ 64,000		$ 200,000
		2		64,000		200,000
		3		64,000		200,000
		4		24,000		160,000
		5		24,000		160,000
				$240,000		$ 920,000
Proposal B:	$320,000	1		$ 26,000		$ 90,000
		2		26,000		90,000
		3		6,000		70,000
		4		6,000		70,000
		5		(44,000)		20,000
				$ 20,000		$340,000
Proposal C:	$108,000	1		$ 33,400		$ 55,000
		2		31,400		53,000
		3		28,400		50,000
		4		25,400		47,000
		5		23,400		45,000
				$142,000		$ 250,000
Proposal D:	$400,000	1		$100,000		$ 180,000
		2		100,000		180,000
		3		80,000		160,000
		4		20,000		100,000
		5		0		80,000
				$300,000		$700,000

The company's capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average rate of return of 12% is required on all projects. If the preceding standards are met, the net present value method and present value indexes are used to rank the remaining proposals.

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:

1. Compute the cash payback period for each of the four proposals.

	Cash Payback Period
Proposal A	3 years 6 months
Proposal B	4 years
Proposal C	2 years
Proposal D	2 years 3 months

2. Giving effect to straight-line depreciation on the investments and assuming no estimated residual value, compute the average rate of return for each of the four proposals. If required, round your answers to one decimal place.

	Average Rate of Return
Proposal A	%
Proposal B	%
Proposal C	%
Proposal D	%

3. Using the following format, summarize the results of your computations in parts (1) and (2) by placing the calculated amounts in the first two columns on the left and indicate which proposals should be accepted for further analysis and which should be rejected. If required, round your answers to one decimal place.

Proposal	Cash Payback Period	Average Rate of Return		Accept or Reject
A	3 years, 6 months	%		Reject
B	4 years	%		Reject
C	2 years	%		Accept
D	2 years, 3 months	%		Accept

4. For the proposals accepted for further analysis in part (3), compute the net present value. Use a rate of 15% and the present value of $1 table above. Round to the nearest dollar.

Select the proposal accepted for further analysis.	Proposal C	Proposal D
Present value of net cash flow total	$	$
Less amount to be invested	$	$
Net present value	$	$

5. Compute the present value index for each of the proposals in part (4). If required, round your answers to two decimal places.

Select proposal to compute Present value index.	Proposal C	Proposal D
Present value index (rounded)	$	$

6. Rank the proposals from most attractive to least attractive, based on the present values of net cash flows computed in part (4).

Rank 1st	Proposal D
Rank 2nd	Proposal C

7. Rank the proposals from most attractive to least attractive, based on the present value indexes computed in part (5).

Rank 1st	Proposal C
Rank 2nd	Proposal D

8. The analysis indicates that although Proposal D  has the larger net present value, it is not as attractive as Proposal C  in terms of the amount of present value per dollar invested. Proposal D  requires the larger investment. Thus, management should use investment resources for Proposal C  before investing in Proposal D , absent any other qualitative considerations that may impact the decision.

NOTE: I just need the boxes with "$" and "%" answered. Everything else I have already answered.

Answer 1

2	Average rate of return=Average net cash flow/Investment
	Average net cash flow=Total net cash flow/number of years
						Proposal A	Proposal B	Proposal C	Proposal D
	Total net cash flow				a	920000	340000	250000	700000
	Number of years				b	5	5	5	5
	Average net cash flow				c=a/b	184000	68000	50000	140000
	Investment				d	680000	320000	108000	400000
	Average rate of return				e=c/d	27.1%	21.3%	46.3%	35.0%
			Average rate of return
	Proposal A		27.1%
	Proposal B		21.3%
	Proposal C		46.3%
	Proposal D		35.0%
3	Proposal	Cash payback period		Average rate of return	Accept or reject
	A	3 years,6 months		27.1%	Reject
	B	4 years		21.3%	Reject
	C	2 years		46.3%	Accept
	D	2 years, 3 months		35.0%	Accept
4						Proposal C	Proposal D
	Present value of net cash flow total				(Note:1)	170023	494780
	Less: amount to be invested					108000	400000
	Net present value					62023	94780
	Present value of net cash flow total:
	Proposal C
	Year	Cash flow	Present value at 15%	Present value of cash flow
		a	b	a*b
	1	55000	0.870	47826.09
	2	53000	0.756	40076
	3	50000	0.658	32876
	4	47000	0.572	26872
	5	45000	0.497	22373
		Total		170023
	Proposal D
	Year	Cash flow	Present value at 15%	Present value of cash flow
		a	b	a*b
	1	180000	0.870	156521.7
	2	180000	0.756	136106
	3	160000	0.658	105203
	4	100000	0.572	57175
	5	80000	0.497	39774
		Total		494780
5	Present value index=Present value of net cash flow total/Amount to be invested
						Proposal C	Proposal D
	Present value of net cash flow total				a	170023	494780
	Amount to be invested				b	108000	400000
	Present value index				a/b	1.57	1.24
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