Average rate of return method, net present value method, and analysis for a serv

Question

Average rate of return method, net present value method, and analysis for a service company The capital investment committee of Touch of Eden Landscaping Company is considering two capital investments. The estimated income from operations and net cash flows from each investment are as follows: Each project requires an investment of $60000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 12% for purposes of the net present value analysis. Instructions 1. Compute the following: The average rate of return for each investment. Round to one decimal place. The net present value for each investment. Use the present value of $1 table appearing in this chapter (Exhibit 2). Round present values to the nearest dollar. 2 Prepare a brief report for the capital investment committee, advising it on the relative merits of the two investments.

Explanation / Answer

1. a. Average rate of return for each investment :

Average rate of return = Average income from operations / Net investment in the project x 100

Front-End Loader : ($ 51,000 / 5) / $ 60,000 x 100 = 17%

Greenhouse Fixtures : ( $ 51,000 / 5) / $ 60,000 x 100 = 17%

b. Net present value at a discount rate of 12% for each investment :

Front-End Loader: 35,000 (0.893) + 32,000 (0.797) + 24,000 ( 0.712) + 10,000 (1.203) - 60,000 = $ ( 31,255 + 25,504 + 17,088 + 12,030 - 60,000) = $ 25,877

Greenhouse Fixtures : $ 22,200( 3.605) - $ 60,000 = $ 20,031

2. Both investments have the same accounting rate of return , but investment should be made in FrontEnd Loader since it has a higher NPV at the company's required rate of return, as compared to Greenhouse Fixtures.

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