Lados Company operates a chain of sandwich shops.

The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of $8,400,000. Expected annual net cash inflows are $1,500,000 for 10 years, with zero residual value at the end of 10 years. Under Plan B, Lados Company would open three larger shops at a cost of $8,240,000. This plan is expected to generate net cash inflows of $1,020,000 per year for 10 years, the estimated useful life of the properties. Estimated residual value for Plan B is $1,000,000. Lados Company uses straight-line depreciation and requires an annual return of 6%.

Requirement 1. Compute the payback, the ARR, the NPV, and the profitability index of these two plans.

Calculate the payback for both plans. (Round your answers to one decimal place, X.X.)

		/		=	Payback
Plan A		/		=		years
Plan B		/		=		years

Calculate the ARR (accounting rate of return) for both plans. (Round your answers to the nearest tenth percent, X.X%.)

		/		=	ARR
Plan A		/		=		%
Plan B		/		=		%

Caclulate the NPV (net present value) of each plan. Begin by calculating the NPV of Plan A. (Complete all answer boxes. Enter a "0" for any zero balances or amounts that do not apply to the plan. Enter any factor amounts to three decimal places, X.XXX. Use parentheses or a minus sign for a negative net present value.)

Plan A:		Net Cash	Annuity PV Factor	PV Factor	Present
Years		Inflow	(i=6%, n=10)	(i=6%, n=10)	Value
1 - 10	Present value of annuity
10	Present value of residual value
	Total PV of cash inflows
0	Initial Investment
	Net present value of Plan A

Calculate the NPV of Plan B. (Complete all answer boxes. Enter a "0" for any zero balances or amounts that do not apply to the plan. Enter any factor amounts to three decimal places, X.XXX. Use parentheses or a minus sign for a negative net present value.)

Plan B:		Net Cash	Annuity PV Factor	PV Factor	Present
Years		Inflow	(i=6%, n=10)	(i=6%, n=10)	Value
1 - 10	Present value of annuity
10	Present value of residual value
	Total PV of cash inflows
0	Initial Investment
	Net present value of Plan B

Calculate the profitability index of these two plans. (Round to two decimal places X.XX.)

		/		=	Profitability index
Plan A		/		=
Plan B		/		=

Requirement 2. What are the strengths and weaknesses of these capital budgeting methods?

Match the term with the strengths and weaknesses listed for each of the four capital budgeting models.

Capital Budgeting Method	Strengths/Weaknesses of Capital Budgeting Method
	Is based on cash flows, can be used to assess profitability, and takes into account
	the time value of money. It has none of the weaknesses of the other models.
	Is easy to understand, is based on cash flows, and highlights risks.
	However, it ignores profitability and the time value of money.
	Can be used to assess profitability, but it ignores the time value of money.
	It allows us to compare alternative investments in present value terms and it also
	accounts for differences in the investments initial cost. It has none of the
	weaknesses of the other models.

Requirement 3. Which expansion plan should Lados Company choose? Why?

Lados CompanyLados Company

should invest in

Plan A

Plan B

because it has a

longer

shorter

payback period, a

higher

lower

ARR, a

higher

lower

net present value, and a

higher

lower

profitability index.

Requirement 4. Estimate Plan A's IRR. How does the IRR compare with the company's required rate of return?

The IRR (internal rate of return) of Plan A is between

8%-9%

9%-10%

10%-12%

12%-14%

14%-15%

.This rate

does not exceed

exceeds

the company's hurdle rate of 6%.