1. Average Rate of Return Method, A method of analysis of proposed capital investments that focuses on the present value of the cash flows expected from the investments.Net Present Value Method, and Analysis for a service company

   The capital investment committee of Arches Landscaping Company is considering two capital investments. The estimated income from operations and net cash flows from each investment are as follows:

   	Front-End Loader					Greenhouse
   Year	Income from Operations		Net Cash Flow			Income from Operations		Net Cash Flow
   1	$61,600		$186,000			$129,000		$298,000
   2	61,600		186,000			99,000		251,000
   3	61,600		186,000			49,000		177,000
   4	61,600		186,000			22,000		121,000
   5	61,600		186,000			9,000		83,000
   Total	$308,000		$930,000			$308,000		$930,000

   Each project requires an investment of $560,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 10% for purposes of the net present value analysis.

   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:

   1a. Compute the average rate of return for each investment. If required, round your answer to one decimal place.

   	Average Rate of Return
   Front-End Loader	%
   Greenhouse	%

   1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, use the minus sign to indicate a negative net present value.

   	Front-End Loader	Greenhouse
   Present value of net cash flow	$	$
   Amount to be invested	$	$
   Net present value	$	$

   2. Prepare a brief report for the capital investment committee, advising it on the relative merits of the two investments.

   The front-end loader has a smaller

   • smaller
   • larger
   net present value because the cash flows occur later
   • earlier
   • later
   in time compared to the greenhouse. Thus, if only one of the two projects can be accepted, the greenhouse
   • front-end loader
   • greenhouse
   would be the more attractive.

   Feedback

   1a. Divide the estimated average annual income by the average investment.

   1b. For each investment, multiply the present value factor for each year (Exhibit 2) by that year's net cash flow. Subtract the amount to be invested from the total present value of the net cash flow. Which investment offers the more favorable net present value?

   2. Consider when cash flows are received and the time value of money.

   Learning Objective 2, Learning Objective 3.

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