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: Front-End Loader Greenhouse Fixtures Year Income from Operations Net Cash Flow Income from Operations Net Cash Flow 1 $23,000 $ 35,000 $10,200 $ 22,200 2 20,000 32,000 10,200 22,200 3 12,000 24,000 10,200 22,200 4 (2,000) 10,000 10,200 22,200 5 (2,000) 10,000 10,200 22,200 $51,000 $111,000 $51,000 $111,000 Each project requires an investment of $60,000. 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. Present Value of $1 at Compound Interest Year 6% 10% 12% 15% 20% 1 0.943 0.909 0.893 0.870 0.833 2 0.890 0.826 0.797 0.756 0.694 3 0.840 0.751 0.712 0.658 0.579 4 0.792 0.683 0.636 0.572 0.482 5 0.747 0.621 0.567 0.497 0.402 6 0.705 0.564 0.507 0.432 0.335 7 0.665 0.513 0.452 0.376 0.279 8 0.627 0.467 0.404 0.327 0.233 9 0.592 0.424 0.361 0.284 0.194 10 0.558 0.386 0.322 0.247 0.162 Required:

Explanation / Answer

NPV of both the investments is calculated as under:

Project Front End loader is more profitable.

Front End Loader Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Cash Outflow ($60,000) Cash Inflow $35,000 $32,000 $24,000 $10,000 $10,000 Net Cash Flow ($60,000) $35,000 $32,000 $24,000 $10,000 $10,000 Life 5 years Required Rate of Return is 12% Present Value factor 1 0.893 0.797 0.712 0.636 0.567 Present Value of Cash outflow -60,000 Present Value of Cash inflow 31,255 25,504 17,088 6,360 5,670 Net Present value -60,000 31,255 25,504 17,088 6,360 5,670 25,877 GreenHouse Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Cash Outflow ($60,000) Cash Inflow $22,200 $22,200 $22,200 $22,200 $22,200 Net Cash Flow ($60,000) $22,200 $22,200 $22,200 $22,200 $22,200 Life 5 years Required Rate of Return is 12% Present Value factor 1 0.893 0.797 0.712 0.636 0.567 Present Value of Cash outflow -60,000 Present Value of Cash inflow 19,825 17,693 15,806 14,119 12,587 Net Present value -60,000 19,825 17,693 15,806 14,119 12,587 20,031

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