Dominique’s Frozen Food Company makes frozen
dinners and sells them to retail outlets near London. Dominique has just inherited
£10,000 and has decided to invest it in the business. She is trying to decide
between the following alternatives:

Alternative A: Buy a £10,000 contract, payable immediately, from a local reputable
sales promotion agency. The agency would provide various advertising services,
as specified in the contract, over the next ten years. Dominique is convinced
that the sales promotion would increase net cash inflow from operations, through
increased volume, by £2,000 per year for the first five years, and by £1,000 per year
thereafter. There would be no effect after the ten years had elapsed.
Alternative B: Buy new mixing and packaging equipment, at a cost of
£10,000, which would reduce operating cash outflows by £1,500 per year for the
next ten years. The equipment would have zero salvage value at the end of the
ten years.
Ignore any tax effect.
1. Compute the rates of return on initial investment by the accounting
model for both alternatives. j
2. Compute the rates of return by the discounted-cash-flow model for
both alternatives.
3. Are the rates of return different under the discounted-cash-flow
model? Explain.