Capital Rationing Decision for a Service Company Involving Four Proposals

Clearcast Communications Inc. is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated income from operations, and net cash flow for each proposal are as follows:

	Investment	Year		Income from Operations		Net Cash Flow
Proposal A:	$450,000	1		$ 30,000		$ 120,000
		2		30,000		120,000
		3		20,000		110,000
		4		10,000		100,000
		5		(30,000)		60,000
				$ 60,000		$510,000
Proposal B:	200,000	1		$ 60,000		$ 100,000
		2		40,000		80,000
		3		20,000		60,000
		4		(10,000)		30,000
		5		(20,000)		20,000
				$ 90,000		$290,000
Proposal C:	$320,000	1		$ 36,000		$ 100,000
		2		26,000		90,000
		3		26,000		90,000
		4		16,000		80,000
		5		16,000		80,000
				$120,000		$ 440,000
Proposal D:	$540,000	1		$92,000		$ 200,000
		2		72,000		180,000
		3		52,000		160,000
		4		12,000		120,000
		5		(8,000)		100,000
				$220,000		$760,000

The company's capital rationing policy requires a maximum cash payback period of 3 years. In addition, a minimum average rate of return of 12% is required on all projects. If the preceding standards are met, the net present value method and present value indexes are used to rank the remaining proposals.

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:

1. Compute the cash payback period for each of the four proposals.

	Cash Payback Period
Proposal A	4 years3 years3 years 6 months2 years3 years 9 months4 years
Proposal B	2 years2 years 4 months3 years3 years 3 months4 years2 years 4 months
Proposal C	2 years3 years 3 months2 years 9 months3 years 6 months4 years3 years 6 months
Proposal D	3 years3 years 3 months2 years 3 months2 years 8 months3 years 10 months3 years

2. Giving effect to straight-line depreciation on the investments and assuming no estimated residual value, compute the average rate of return for each of the four proposals. If required, round your answers to one decimal place.

	Average Rate of Return
Proposal A	fill in the blank 5 %
Proposal B	fill in the blank 6 %
Proposal C	fill in the blank 7 %
Proposal D	fill in the blank 8 %

3. Using the following format, summarize the results of your computations in parts (1) and (2). By placing the computed amounts in the first two columns on the left and indicate which proposals should be accepted for further analysis and which should be rejected. If required, round your answers to one decimal place.

Proposal	Cash Payback Period	Average Rate of Return		Accept or Reject
A	2 yrs.3 yrs., 6 mos.4 yrs.2 yrs., 8 mos.4 yrs.	fill in the blank 10 %		AcceptRejectReject
B	3 yrs., 4 mos.2 yrs., 4 mos.4 yrs.2 yrs., 8 mos.2 yrs., 4 mos.	fill in the blank 13 %		AcceptRejectAccept
C	2 yrs.2 yrs., 8 mos.3 yrs., 6 mos.4 yrs.3 yrs., 6 mos.	fill in the blank 16 %		AcceptRejectReject
D	3 yrs.2 yrs., 3 mos.2 yrs., 8 mos.4 yrs.3 yrs.	fill in the blank 19 %		AcceptRejectAccept

4. For the proposals accepted for further analysis in part (3), compute the net present value. Use a rate of 12% and the present value of $1 table above. Round to the nearest dollar.

Note: Select the proposals in alphabetic order.

Select the proposal accepted for further analysis.	Proposal AProposal BProposal CProposal DProposal B	Proposal AProposal BProposal DProposal CProposal D
Present value of net cash flow total	$fill in the blank 23	$fill in the blank 24
Less amount to be invested	$fill in the blank 25	$fill in the blank 26
Net present value	$fill in the blank 27	$fill in the blank 28

5. Compute the present value index for each of the proposals in part (4). If required, round your answers to two decimal places.

Note: Select the proposals in alphabetic order.

Select proposal to compute Present value index.	Proposal AProposal BProposal CProposal DProposal B	Proposal AProposal BProposal CProposal DProposal D
Present value index (rounded)	fill in the blank 31	fill in the blank 32

6. Rank the proposals from most attractive to least attractive, based on the present values of net cash flows computed in part (4).

Rank 1st	Proposal AProposal BProposal CProposal DProposal D
Rank 2nd	Proposal AProposal BProposal CProposal DProposal B

7. Rank the proposals from most attractive to least attractive, based on the present value indexes computed in part (5).

Rank 1st	Proposal AProposal BProposal CProposal DProposal B
Rank 2nd	Proposal AProposal BProposal CProposal DProposal D

8. The present value indexes indicate that although Proposal

ABCDD

has the larger net present value, it is not as attractive as Proposal

ABCDB

in terms of the amount of present value per dollar invested. Proposal

ABCDD

requires the larger investment. Thus, management should use investment resources for Proposal

ABCDB

before investing in Proposal

ABCDD

, absent any other qualitative considerations that may impact the decision.