Capital Rationing Decision Involving Four Proposals

Kopecky Industries 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:

Project Name	Sierra		Tango		Uniform		Victor
	Investment	$751,674	Investment	$2,770,865	Investment	$1,762,515	Investment	$1,013,346
Year	Income from Operations	Net Cash Flows	Income from Operations	Net Cash Flows	Income from Operations	Net Cash Flows	Income from Operations	Net Cash Flows
1	$77,000	$220,000	$285,000	$950,000	$202,500	$450,000	$109,000	$380,000
2	77,500	220,000	285,275	950,000	202,500	450,000	109,000	380,000
3	78,000	220,000	285,550	950,000	202,500	450,000	109,000	380,000
4	78,500	220,000	285,825	950,000	202,500	450,000	109,000	380,000
5	79,000	220,000	286,100	950,000	202,500	450,000	109,000	380,000
Total	$390,000	$1,100,000	$1,427,750	$4,750,000	$1,012,500	$2,250,000	$545,000	$1,900,000

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

The company's capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average rate of return of 20% 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.

Required:

1. Compute the cash payback period for each of the four proposals. Assume that net cash flows are uniform throughout the year.

	Cash Payback Period
Proposal Sierra	3 years 5 months
Proposal Tango	2 years 11 months
Proposal Uniform	3 years 11 months
Proposal Victor	2 years 8 months

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. Round to one decimal place.

	Average Rate of Return
Proposal Sierra	%
Proposal Tango	%
Proposal Uniform	%
Proposal Victor	%

3. Using the results from parts (1) and (2) determine which proposals should be accepted for further analysis and which should be rejected.

	Accept / Reject
Proposal Sierra	Reject
Proposal Tango	Accept for further analysis
Proposal Uniform	Reject
Proposal Victor	Accept for further analysis

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. If required, use the minus sign to indicate a subtraction or negative net present value.

Select the proposal accepted for further analysis.	Proposal Tango	Proposal Victor
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). Round to two decimal places.

Select the proposal to compute present value index.	Proposal Tango	Proposal Victor
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 Tango
Rank 2nd	Proposal Victor

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

Rank 1st	Proposal Victor
Rank 2nd	Proposal Tango

8. Based on your calculations above, complete the statements below.

Looking at the present value computations, Proposal Tango has the larger net present value. Proposal Victor is attractive in terms of amount of present value per dollar invested. Comparing the two proposals, their present value indices have a moderate range . Lastly, Proposal Tango has the larger initial investment. Considering all this information, Kopecky should proceed with Proposal Victor .

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