1. Compute the payback, the ARR, the NPV, and the profitability index of these two plans. 2. What are the strengths and weaknesses of these capital budgeting methods? 3. Which expansion plan should Lajos Company choose? Why? 4. Estimate Plan A's IRR. How does the IRR compare with the company's required rate of return? The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of $8,440,000. Expected annual net cash inflows are $1,500,000 for 10 years, with zero residual value at the end of 10 years. Under Plan B, Lajos Company would open three larger shops at a cost of $8,250,000. This plan is expected to generate net cash inflows of $1,080,000 per year for 10 years, the estimated useful life of the properties. Estimated residual value for Plan B is $1,100,000. Lajos Company uses straight-line depreciation and requires an annual return of 10%. (Click the icon to view Present Value of $1 table.) (Click the icon to view Present Value of Ordinary Annuity of $1 table.) (Click the icon to view Future Value of $1 table.) (Click the icon to view Future Value of Ordinary Annuity of $1 table.) Requirement 1. Compute the payback, the ARR, the NPV, and the profitability index of these two plans. Calculate the payback for both plans. (Round your answers to one decimal place, X.X.) Calculate the ARR (accounting rate of return) for both plans. (Round your answers to the nearest tenth percent, X.X\%.) Caclulate the NPV (net present value) of each plan. Begin by calculating the NPV of Plan A. (Complete all answer boxes. Enter a "0" for any zero balances or amounts that do not apply to the plan. Enter any factor amounts to three decimal places X.XXX. Use parentheses or a minus sign for a negative net present value.) Calculate the NPV of Plan B. (Complete all answer boxes. Enter a "0" for any zero balances or amounts that do not apply decimal places, X.XXX. Use parentheses or a minus sign for a negative net present value.) Calculate the profitability index of these two plans. (Round to two decimal places X.XX.) Plan A = Profitability index Plan B Capital Budgeting Method Strengths/Weaknesses of Capital Budgeting Method Is based on cash flows, can be used to assess profitability, and takes into account the time value of money. It has none of the weaknesses of the other models. Is easy to understand, is based on cash flows, and highlights risks. However, it ignores profitability and the time value of money. Can be used to assess profitability, but it ignores the time value of money. It allows us to compare alternative investments in present value terms and it also accounts for differences in the investments' initial cost. It has none of the weaknesses of the other models. Requirement 3. Which expansion plan should Lajos Company choose? Why? Lajos Company should invest in because it has a payback period, a ARR, a net present value, and a profitability index. Requirement 4. Estimate Plan A's IRR. How does the IRR compare with the company's required rate of return The IRR (internal rate of return) of Plan A is between This rate the company's hurdle rate of 10%
