PA11-3 Comparing, Prioritizing Multiple Projects (LO 11-1, 11-2, 11-3, 11-6 Heam
ID: 2432975 • Letter: P
Question
PA11-3 Comparing, Prioritizing Multiple Projects (LO 11-1, 11-2, 11-3, 11-6 Heame Company has a number of potential capital investments.Because potential capital investments. Because these projects vary in nature,initial investment, and time horizon, management is inding it ditfcult to compate them. Assume straight line depreclation method is used. Project 1: Retooling Manufacturing Facility This project would require an initial investment of $5,000,000. It would salvage value of $1,036,000 Project 2: Purchase Patent for New Product The patent would cost $3,505,000, which would be fully amortized over five years. Production of this product would generate $490,700 additional annual net income for Hoarme. Project 3: Purchase a New Fleet of Delivery Trucks s and a Hearne could purchase 25 new delivery trucks at a cost of $130,000 each. The Seet would have a useful life of 10 years, and each truck would have a salvage value of $5,300 Purchasing the fleet would allow Heame to expand its customer torritory resulting in $455,000 of additional net income per year. Required: 1. Determine each project's accounting rate of retum. (Round your answers to 2 decimal places.) Project 1 Project 2 Project 3 2. Determine each project's payback period. (Round your answers to 2 decimal places) 20 F 9 0Explanation / Answer
Accounting rate of return = Annual net income / Initial investment So first we will calculate each project Annual net income and cash flow. Discount rate 10% Project 1 Initial investment $ 5,000,000 Salvage value 1036000 Depreciation (5000000-1036000)÷8 = $ 495,500 Cash flow per year $ 892,000 Annual net income cash flow - depreciation 892000-495500 $ 396,500 Project 2 Initial investment $ 3,505,000 Salvage value 0 Amortization 3505000 ÷ 5 $ 701,000 Annual net income 490700 Cash flow per year Annual net income + Amortization 490700+701000 $ 1,191,700 Project 3 Initial investment $ 3,250,000 Salvage value 132500 (25 x 130000) (25 x 5300) Depreciation (3250000-132500) ÷ 10 $ 311,750 Annual net income 455000 Cash flow per year Annual net income + Depreciation 455000+311750 $ 766,750 using the formula of ARR Accounting rate of return Project 1 7.93% (396500/5000000) Project 2 14.00% (490700/3505000) Project 3 14.00% (455000/3250000) Payback period Payback period Project 1 5.61 Years (5000000/892000) Project 2 2.94 Years (3505000/1191700) Project 3 4.24 Years (3250000/766750) NPV Net Present value Project 1 $ 242,055.81 (-5000000+892000 x 5.33493 +1036000 x 0.46651) Project 2 $ 1,012,480.59 (-3505000+1191700 x 3.79079) Project 3 $ 1,512,431.31 (-3250000+766750 x 6.14457 + 132500 x 0.38554) Profitability Index Rank Project 1 1.05 3 =5242055.81/5000000 Project 2 1.29 2 =4517480.59/3505000 Project 3 1.47 1 =4762431.31/3250000 Profitability index = Present value of cash inflows/ Initial investment Note: I have tried my best for corresct solution, still need any further help, please ask in comment, Thanks
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