Hearne Company has a number of potential capital investments. Because these proj
ID: 2454714 • Letter: H
Question
Hearne Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them. Assume straight line depreciation method is used.
This project would require an initial investment of $5,100,000. It would generate $910,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,060,000.
The patent would cost $3,575,000, which would be fully amortized over five years. Production of this product would generate $536,250 additional annual net income for Hearne.
Hearne could purchase 25 new delivery trucks at a cost of $140,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,500. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $525,000 of additional net income per year.
Determine each project's accounting rate of return. (Round your answers to 2 decimal places.)
Determine each project's payback period.
Using a discount rate of 10 percent, calculate the net present value of each project. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Round your intermediate calculations to 4 decimal places and final answers to 2 decimal places.)
Determine the profitability index of each project and prioritize the projects for Hearne. (Round your intermediate calculations to 2 decimal places. Round your final answers to 4 decimal places.)
Hearne Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them. Assume straight line depreciation method is used.
Explanation / Answer
Question 1. Project 1 Depreciation = (5100000-1060000)/8 = Account rate of return = (910000-505000)/5100000 =7.94% Project 2. Accounting Rate of Return = 536250/3575000 = 15% Project 3. Accounting Rate of return = 525000/(25*140000) = 15% Question 2. Project 1 Operating Net cash Payback Payback Year Cashflows Solvage inflows Amount year 1 910000 910000 910000 1.00 2 910000 910000 910000 1.00 3 910000 910000 910000 1.00 4 910000 910000 910000 1.00 5 910000 910000 910000 1.00 6 910000 910000 550000 0.60 7 910000 910000 0.00 8 910000 1060000 1970000 0.00 Total 5100000 5.60 Project 2 Net Add back Net Payback Payback Year Income Depreciation Cashinflows Amount year 1 536250 715000 1251250 1251250 1.00 2 536250 715000 1251250 1251250 1.00 3 536250 715000 1251250 1072500 0.86 4 536250 715000 1251250 5 536250 715000 1251250 Total 3575000 2.86 Project 3 Net Add back Operating Solvage Net Payback Payback Year Income Depreciation Cash Cashinflows Amount year 1 525000 336250 861250 861250 861250 1 2 525000 336250 861250 861250 861250 1 3 525000 336250 861250 861250 861250 1 4 525000 336250 861250 861250 861250 1 5 525000 336250 861250 861250 55000 0.06 6 525000 336250 861250 861250 0 7 525000 336250 861250 861250 0 8 525000 336250 861250 861250 0 9 525000 336250 861250 861250 0 10 525000 336250 861250 137500 998750 0 3500000 4.06 Question 4. Project 1 Operating Net cash Year Cashflows Solvage inflows 1 910000 910000 2 910000 910000 3 910000 910000 4 910000 910000 5 910000 910000 6 910000 910000 7 910000 910000 8 910000 1060000 1970000 Total 7280000 1060000 8340000 PI = 8340000/5100000 = 1.64 Project 2 Net Add back Net Year Income Depreciation Cashinflows 1 536250 715000 1251250 2 536250 715000 1251250 3 536250 715000 1251250 4 536250 715000 1251250 5 536250 715000 1251250 Total 6256250 PI = 6256250/3575000=1.75 Project 3 Net Add back Operating Solvage Net Year Income Depreciation Cash Cashinflows 1 525000 336250 861250 861250 2 525000 336250 861250 861250 3 525000 336250 861250 861250 4 525000 336250 861250 861250 5 525000 336250 861250 861250 6 525000 336250 861250 861250 7 525000 336250 861250 861250 8 525000 336250 861250 861250 9 525000 336250 861250 861250 10 525000 336250 861250 137500 998750 8750000 PI = 8750000/(140000x25) = 2.5
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