Capital Rationing

JSU Industries manufactures plastic containers used to package a variety of liquid consumer

products (such as fabric softener, cleaners, shampoo, hair spray, and liquid soap). The containers

are manufactured on a job-order basis to customer specifications.

JSU has received five proposals for capital investment projects. Your job is to evaluate these

proposals and rank them in the order in which they should be funded. Begin your analysis by

computing the average rate of return and cash payback period for each proposal. Any project that

has an average rate of return of less than 15 percent or a cash payback period of longer than five

years should be eliminated from further consideration. After this initial screening, compute the net

present value (using a 15 percent discount rate) and internal rate of return for the remaining

projects. Rank the projects based on both their profitability and overall merit to the corporation

(qualitative factors).

Projects: A B C D E

Cost $200,000 $250,000 $325,000 $500,000 $400,000

Life (in years) 8 10 10 10 8

Residual value $0 $0 $0 $0 $0

Annual project income $17,000 $18,000 $33,000 $55,000 $45,000

Annual net cash flows $42,000 $43,000 $65,500 $105,000 $95,000

Project A: This proposal requests funds to purchase hardware and software that will allow the

accounting department to process payroll in-house. Paychecks are currently processed by an

outside payroll service company. The annual increase in net income and cash flows will result

from cost savings if the payroll function is no longer contracted to an outside company.

Project B: This proposal requests funds for new manufacturing equipment. This equipment will

allow JSU Industries to make containers as large as ten gallons. Currently, JSU cannot make

containers that are larger than three gallons.

Project C: This proposal requests funds for equipment to make stick-on labels that are applied to

the plastic containers. Currently, all stick-on labels are ordered from another company. This

supplier has not proven very reliable in meeting delivery deadlines.

Project D: This proposal requests funds for automated manufacturing equipment that will reduce

the cycle time from receipt of a customer order to delivery of that order. JSUs cycle time is

currently seven days. The automated equipment will reduce that time to four days while saving

costs due to the elimination of five jobs. It will also make JSU more competitive; the companys

major competitor currently has a cycle time of five days.

Project E: This proposal requests funds for computerized drafting and design equipment that will

allow engineers to complete manufacturing instructions on special orders more quickly. This

equipment should reduce JSUs cycle time from seven to five days.

Present Value of an Annuity of $1 at Compound Interest

Period 12% 13% 14% 15% 16% 17% 18%

8 4.968 4.799 4.639 4.487 4.344 4.207 4.078

10 5.650 5.426 5.216 5.019 4.833 4.659 4.49