Hearne Company has a number of potential capital investments. Because these proj
ID: 2469586 • 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 $5,150,000. It would generate $919,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,072,000.
The patent would cost $3,610,000, which would be fully amortized over five years. Production of this product would generate $559,550 additional annual net income for Hearne.
Hearne could purchase 25 new delivery trucks at a cost of $145,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,600. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $561,900 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. (Round your answers to 2 decimal places.)
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
1)
Accounting rate of return = Avergae net income per year / Average Investment
Project 1:
Net Income per year = net cash flow – depreciation = $919000 - $509750 = $409250
Accounting Rate of Return = $409250 / [($5150000 + $1072000)/2] = 0.13
Project 2: Purchase Patent for New Product
Net Income per year = $559550
Accounting Rate of Return = $559550 / [(3610000 + 0)/2] = 0.31
Project 3: Purchase a New Fleet of Delivery Trucks
Investment = $145000 x 25 = $3625000
Salvage Value = $5600x25 = $140000
Net income per year = $561900
Accounting Rate of Return = $561900 / [(3625000 + 140000)/2] = 0.30
2) Payback Period
Payback Period = Initial Investment / Annual cash inflow
Project 1: Retooling Manufacturing Facility
Payback period = $5150000 / $919000 = 5.61 years
Project 2: Purchase Patent for New Product
Depreciation per year = $3610000/5 = $722000
Net annual cash inflow = annual net income + annual depreciation = $559550 + $722000 = $1281550
Payback period =$3610000 / $1281550 = 2.82 years
Project 3: Purchase a New Fleet of Delivery Trucks
Depreciation per year = ($3625000 - $140000)/10 = $348500
Net annual cash inflow = annual net income + annual depreciation = $561900 + $348500 = $ 910400
Payback period = $3625000 / $910400 = 3.98 years
3)
Project 1:
NPV
= - $5150000 + $919000 x PVIFA(10%,8) + 1072000 x PVIF (10%, 8)
= - $5150000 + $919000 x 5.334 + 1072000 x 0.467
= $252570
Project 2:
NPV
= - $3610000 + $1281550 x PVIFA(10%,5)
= - $3610000 + $1281550 x 3.79
= $1247075
Project 3:
NPV
= - $3625000 + $910400 x PVIFA(10%,10) + 140000 x PVIF (10%, 10)
= - $3625000 + $910400 x 6.017 + 140000 x 0.322
=$1897957
4)
Profitability Index
= PV of future cash flows / initial investment
Project 1:
Profitability Index = 5402570 / 5150000 = 1.05
Project 2:
Profitability Index = 4857075 / 3610000 = 1.35
Project 3:
Profitability Index = 5522957/3625000 = 1.52
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