Question
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
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 | $40,000 | $129,000 | $84,000 | $206,000 | ||||||
2 | 40,000 | 129,000 | 64,000 | 174,000 | ||||||
3 | 40,000 | 129,000 | 32,000 | 123,000 | ||||||
4 | 40,000 | 129,000 | 14,000 | 84,000 | ||||||
5 | 40,000 | 129,000 | 6,000 | 58,000 | ||||||
Total | $200,000 | $645,000 | $200,000 | $645,000 |
Each project requires an investment of $400,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% 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 | fill in the blank 1% |
Greenhouse | fill in the blank 2% |
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 | $fill in the blank 4 |
Amount to be invested | fill in the blank 5 | fill in the blank 6 |
Net present value | $fill in the blank 7 | $fill in the blank 8 |
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 in time compared to the greenhouse. Thus, if only one of the two projects can be accepted, the would be the more attractive.
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