1. 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 Operating income, and net cash flow for each proposal are as follows:

   	Investment	Year		Operating Income		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 three 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 years
   Proposal B:	2 years, 4 months
   Proposal C:	3 years, 6 months
   Proposal D:	3 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:	%
   Proposal B:	%
   Proposal C:	%
   Proposal D:	%

   3. Using the following format, summarize the results of your computations in parts (1) and (2). By placing the calculated 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	4 years		%	Reject
   B	2 years, 4 months		%	Accept
   C	3 years, 6 months		%	Reject
   D	3 years		%	Accept

   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.

   Select the proposal accepted for further analysis.	Proposal B	Proposal D
   Present value of net cash flow total	$	$
   Amount to be invested
   Net present value	$	$

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

   Select proposal to compute Present value index.	Proposal B	Proposal D
   Present value index (rounded)

   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 D
   Rank 2nd	Proposal B

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

   Rank 1st	Proposal B
   Rank 2nd	Proposal D

   8. The analysis indicates that although Proposal D has the larger net present value, it is not as attractive as Proposal B in terms of the amount of present value per dollar invested. Proposal D requires the larger investment. Thus, management should use investment resources for Proposal B before investing in Proposal D , absent any other qualitative considerations that may impact the decision.

   Feedback

   1. For each project, start with year 1 and accumulate the net cash flows until the amount to be invested is reached.

   2. Divide the estimated average annual income by the average investment.

   3. Which proposals meet the payback requirements and the minimum average rate of return?

   4, 6. For each proposal, multiply the present value factor by the net cash flow (Refer Exhibit 2 in the text). Subtract the amount to be invested from the total present value of the net cash flow. Which proposal offers the more favorable net present value?

   5, 7. Divide the total present value of net cash flow by the amount to be invested. Which proposal has the higher present value index?

   8. Compare present value indexes and the net present value compared to the investment.

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