Question

Ranking Investment Proposals:Payback Period, Accounting Rate of Return, and Net Present Value Presented is information pertaining to the cash flows of three mutually exclusive investment proposals: Proposal X Proposal Y Proposal Z Initial investment $81,000 $81,000 $81,000 Cash flow from operations Year 1 80,000 40,500 81,000 Year 2 1,000 40,500 Year 3 41,000 41,000 Disinvestment Life (years) 3 years 3 years 1 year 0 (a) Select the best investment proposal using the payback period, the accounting rate of return on initial investment, and the net present value criteria. Assume that the organization's cost of capital is 14 percent. • Round accounting rate of return four decimal places. • Round net present value to the nearest whole number. • Use negative signs with your answers when appropriate. Best proposal Proposal Z 1Z Payback period (years) Accounting rate of return Net present value Proposal X 2 16.8728 x 0x Proposal Y 2 17 x 0x R oxy (b) Factors explaining the differences in rankings include all of the following except: The net present value method considers the cost of capital while the payback method does not discount future cash flows. While the accounting rate of return explicitly considers the cost of the asset as part of annual depreciation the net present value method considers the cost of the asset as part of the initial investment. Net present value considers the timing of cash flows while payback considers only total cash flows. The accounting rate of return considers profitability while payback only considers the time required to recover the investment. Mark 1.00 out of 1.00

Answer 1

Proposal X
Computation of Annual income
Year	Estimated Annual Cash inflow (A)	Depreciation (	Net Income
1	$80,000	$27,000	$53,000
2	$1,000	$27,000	-$26,000
3	$41,000	$27,000	$14,000
	Total		$41,000
	Average Accounting Income = 41000/3=$13667
	Average Investment= 81000/2=40500
	Accounting Rate of Return= Average Income / Average Investment
	=13667/40500= 33.74%

Computation of NPV- Project X
Year	Cash Flow (A)	PVAF @14% (B)	PV (AXB)
0	-$81,000	1.0000	-$81,000
1	$80,000	0.8772	$70,175
2	$1,000	0.7695	$769
3	$41,000	0.6750	$27,674
	NPV		$17,619

Proposal Y
Computation of Annual income
Year	Estimated Annual Cash inflow (A)	Depreciation (	Net Income
1	$40,500	$27,000	$13,500
2	$40,500	$27,000	$13,500
3	$41,000	$27,000	$14,000
	Total		$41,000
	Average Accounting Income = 41000/3=$13667
	Average Investment= 81000/2=40500
	Accounting Rate of Return= Average Income / Average Investment
	=13667/40500= 33.74%

Computation of NPV- Project Y
Year	Cash Flow (A)	PVAF @14% (B)	PV (AXB)
0	-$81,000	1.0000	-$81,000
1	$40,500	0.8772	$35,526
2	$40,500	0.7695	$31,163
3	$41,000	0.6750	$27,674
	NPV		$13,364

Proposal Z
	Accounting Rate of Return= Average Income / Average Investment
	(81000/81000)=100%
Computation of NPV- Project Z
Year	Cash Flow (A)	PVAF @14% (B)	PV (AXB)
0	-$81,000	1.0000	-$81,000
1	$81,000	0.8772	$71,053
	NPV		-$9,947