Average Rate of Return Method, Net Present Value Method, and Analysis The capita

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Average Rate of Return Method, Net Present Value Method, and Analysis

The capital investment committee of Cross Continent Trucking Inc. 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 $440,000. 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.

Required:

1a. Compute the average rate of return for each investment. If required, round your answer to one decimal place.

1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, use the minus sign to indicate a negative net present value.

2. The warehouse has a SelectlargersmallerItem 9  net present value because SelectlargersmallerItem 10  cash flows occur earlier in time compared to the tracking technology. Thus, if only one of the two projects can be accepted, the Selecttracking technologywarehouseItem 11  would be the more attractive.

Warehouse Tracking Technology Year Income from
Operations Net Cash
Flow Income from
Operations Net Cash
Flow 1 $30,800 $98,000 $65,000 $157,000 2 30,800 98,000 49,000 132,000 3 30,800 98,000 25,000 93,000 4 30,800 98,000 11,000 64,000 5 30,800 98,000 4,000 44,000 Total $154,000 $490,000 $154,000 $490,000

Explanation / Answer

(1-a)

Average rate of return (ARR) = Average income from operations / Investment

ARR, Warehouse = ($154,000 / 5) / $440,000 = $30,800 / $440,000 = 0.07 = 7%

ARR, Tracking = ($154,000 / 5) / $440,000 = $30,800 / $440,000 = 0.07 = 7%

(1-b)

Depreciation being non-cash expense, is not included in NPV analysis.

Note: First 2 questions are answered.

WAREHOUSE Year Net Cash Flow ($) Discount factor @12% Discounted net cash flow ($) 1 98,000 0.8929 87,500 2 98,000 0.7972 78,125 3 98,000 0.7118 69,754 4 98,000 0.6355 62,281 5 98,000 0.5674 55,608 Total PV ($) = 3,53,268 Less: Investment ($) -4,40,000 NPV ($) = -86,732 TRACKING TECHNOLOGY Year Net Cash Flow ($) Discount factor @12% Discounted net cash flow ($) 1 1,57,000 0.8929 1,40,179 2 1,32,000 0.7972 1,05,230 3 93,000 0.7118 66,196 4 64,000 0.6355 40,673 5 44,000 0.5674 24,967 Total PV ($) = 3,77,244 Less: Investment ($) -4,40,000 NPV ($) = -62,756

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