Question
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PA113 Comparing, Prioritizing Multiple Projects LO 11-1, 112, 11-3, 116] Hearme Company has a number of potential tapital investments. Because these projects vary in nature, initial investment, and time horizan, management is findng & difficultl to compare them Assume straight Ine depreciation method is used Project 1: Retooling Manufacturing Facility This project would require an initial ivestment of $4,950,000. It would generate $883.000 in adsitional net cash flow each year The new mac hinery has a useld ife of eight years and a salvage vaue of $1,024.000 Project 2: Purchase Patent for New Product The patent would cost 53.470,000, which would be fuly amortized over fie ysas. Production of this product would generate S468 450 aditional annuai nen neome for Heame Project 3: Purchase a New Fleet of Delivery Trucks Heame coud purchase 26 new delvary bnucks at 3 tost of $125,000 sach. The fleet woud have a uset I have a satrage value of $5.200 Purchasing the flest would alow Ide of 10 years, and each truck would Haame to expand t ts customar temtory resulting in $421.300 of add tional net income per year Requirec: ureme azh rijets each projet's accountng rane of retum (Round your aniswers to 2 d your answers to 2 decimal placasJ Accounting Rate of Return Projeet 1 Project 2 Projsct 3 84.061%
Explanation / Answer
1. Accounting rate of return
Project 1 = (Annual cash flow - Depreciation) / Initial investment = ($883,000 - $490,750) / $4,950,000 = 7.92%
Project 2 = Net income / Initial investment = $468,450 / 3,470,000 = 13.50%
Project 3 = Net income / Initial investment = $421,900 / ($125,000 x 26) = 12.98%
2. Payback period
Project 1 = Initial investment / Annual cash flow = $4,950,000 / $883,000 = 5.60 years
Project 2 = Initial investment / Annual cash flow = $3,470,000 / ($468,450 + $694,000) = 2.99 years
Project 3 = Initial investment / Annual cash flow = ($125,000 x 26) / ($421,900 + $311,480) = 4.31 years
