Average Rate of Return Method, Net Present Value Method, and analysis for a Serv
ID: 2547140 • Letter: A
Question
Average Rate of Return Method, Net Present Value Method, and analysis for a Service Company
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 $368,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% 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. If required, round to the nearest dollar.
2. The net present value exceeds the selected rate established for discounted cash flows (15%), while the does not. Thus, considering only quantitative factors, the investment should be selected.
Warehouse Tracking Technology Year Income from Operations Net Cash Flow Income from Operations Net Cash Flow 1 $ 61,400 $135,000 $ 34,400 $108,000 2 51,400 125,000 34,400 108,000 3 36,400 110,000 34,400 108,000 4 26,400 100,000 34,400 108,000 5 (3,600) 70,000 34,400 108,000 Total $172,000 $540,000 $172,000 $540,000Explanation / Answer
1a.
Average rate of return = Average Income/Initial investment
= ($ 172,000/5)/$ 368,000
= $ 34,400/$ 368,000 = 0.09347826 or 9.35 %
Average Rate of Return
Warehouse
9.35%
Tracking Technology
9.35%
1b.
Warehouse
Year
Cash flow
PV of $ 1
PV
0
$ (368,000)
1
$ (368,000.00)
1
$ 135,000
0.870
$ 117,450.00
2
$ 125,000
0.756
$ 94,500.00
3
$ 110,000
0.756
$ 83,160.00
4
$ 100,000
0.756
$ 75,600.00
5
$ 70,000
0.756
$ 52,920.00
NPV
$ 55,630.00
Tracking Technology
Year
Cash flow
PV of $ 1
PV
0
$ (368,000)
1
$ (368,000.00)
1
$ 108,000
0.870
$ 93,960.00
2
$ 108,000
0.756
$ 81,648.00
3
$ 108,000
0.756
$ 81,648.00
4
$ 108,000
0.756
$ 81,648.00
5
$ 108,000
0.756
$ 81,648.00
NPV
$ 52,552.00
Warehouse
Tracking Technology
Present value of net cash flow total
$ 423,630
$ 420,552
Amount to be invested
$ 368,000
$ 368,000
Net present value
$ 55,630
$ 52,552
2.
NPV is higher for project Warehouse. Hence it should be selected.
Average Rate of Return
Warehouse
9.35%
Tracking Technology
9.35%
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