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

Question

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

The capital investment committee of Ellis Transport and Storage Inc. is considering two investment projects. The estimated income from operations and net cash flows from each investment are as follows:

Each project requires an investment of $400,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 10% 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 (larger or smaller) net present value as tracking technology cash flows occur (earlier, more evenly, or later) in time. Thus, if only one of the two projects can be accepted, the (tracking tech or warehouse) would be the more attractive.

Warehouse Tracking Technology Year Income from
Operations Net Cash
Flow Income from
Operations Net Cash
Flow 1 $40,000 $130,000 $84,000 $208,000 2 40,000 130,000 64,000 176,000 3 40,000 130,000 32,000 124,000 4 40,000 130,000 14,000 85,000 5 40,000 130,000 6,000 57,000 Total $200,000 $650,000 $200,000 $650,000

Explanation / Answer

Answer 1a Calculation of Average rate of return Warehouse Tracking Technology Total Income from operation for 5 years $200,000.00 $200,000.00 / Total No.of years 5 5 Average Return $40,000.00 $40,000.00 / Initial Investment $400,000.00 $400,000.00 Average rate of return 10% 10% Answer 1b Computation of present value of future cash flows Year Discount Factor @ 10% Warehouse Tracking Technology Net Cash flow Present Value Net Cash flow Present Value 1 0.909 $130,000.00 $118,170.00 $208,000.00 $189,072.00 2 0.826 $130,000.00 $107,380.00 $176,000.00 $145,376.00 3 0.751 $130,000.00 $97,630.00 $124,000.00 $93,124.00 4 0.683 $130,000.00 $88,790.00 $85,000.00 $58,055.00 5 0.621 $130,000.00 $80,730.00 $57,000.00 $35,397.00 Present value of future cash flows $492,700.00 $521,024.00 Compute the net present value for each investment Warehouse Tracking Technology Present value of net cash flow total $492,700.00 $521,024.00 Less : Amount to be invested $400,000.00 $400,000.00 Net present value $92,700.00 $121,024.00 Answer 2 The warehouse has a smaller net present value as tracking technology cash flows occur earlier in time. Thus, if only one of the two projects can be accepted, the tracking tech would be the more attractive.

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