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	$25,000		$ 40,000			$11,250		$ 26,250
2	20,000		35,000			11,250		26,250
3	7,000		22,000			11,250		26,250
4	3,000		18,000			11,250		26,250
5	1,250		16,250			11,250		26,250
Total	$56,250		$131,250			$56,250		$131,250

Each project requires an investment of $75,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 12% 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
Greenhouse
Front-End Loader

1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, round to the nearest dollar.

	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 net present value because cash flows occur earlier in time compared to the greenhouse. Thus, if only one of the two projects can be accepted, the would be the more attractive.