Average Rate of Return Method, 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 operating income and net cash flows from each investment are as follows:

	Front-End Loader					Greenhouse
Year	Operating Income		Net Cash Flow			Operating Income		Net Cash Flow
1	$43,700		$136,000			$92,000		$218,000
2	43,700		136,000			70,000		184,000
3	43,700		136,000			35,000		129,000
4	43,700		136,000			15,000		88,000
5	43,700		136,000			6,500		61,000
Total	$218,500		$680,000			$218,500		$680,000

Each project requires an investment of $460,000. 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

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 fill in the blank 1 19 % Greenhouse fill in the blank 2 19 % 1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, round to the nearest dollar. If required, use the minus sign to indicate a negative net present value. Front-End Loader Greenhouse Present value of net cash flow $fill in the blank 3 55,440 $fill in the blank 4 85,010 Amount to be invested fill in the blank 5 75,000 fill in the blank 6 75,000 Net present value $fill in the blank 7 24,941 $fill in the blank 8 19,631 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 net present value because cash flows occur later in time compared to the greenhouse. Thus, if only one of the two projects can be accepted, the greenhouse would be the more attractive.

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