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 Arches 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 Income from Operations $25,000 20,000 7,000 3,000 1,250 $56,250 Income from Operations $11,250 11,250 11,250 11,250 11,250 $56,250 Net Cash Net Cash Year Flow Flow 40,000 35,000 22,000 18,000 16,250 $131,250 s 26,250 26,250 26,250 26,250 26,250 $131,250 Each project requires an investment of $75,000. 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 20% 0.870 0.833 0.797 0.756 0.694 Year 6% 0.943 0.890 0.826 0.840 0.75 0.712 0.658 0.579 0.792 0.683 0.636 0.572 0.482 0.747 0.621 0.567 0.497 0.402 0.705 0.564 0.507 0.432 0.335 0.665 0.513 0.452 0.376 0.279 0.627 0.467 0.404 0.327 0.233 0.592 0.424 0.361 0.284 0.194 0.558 0.386 0.322 0.247 0.162 10% 12% 15% 0.909 0.893 10

Explanation / Answer

1a. Average rate of return =( Average income from operations / Average Investment ) * 100

    Average Income from operations = 56,250 / 5 = 11,250

    Average Investment = 75,000

    ARR = (11,250 / 75,000) * 100 = 15% for both the projects.

1b. Calculation of NPV:

94,631.25

NPV of Front Loader = 99940.75 - 75,000 = 24,940.75

NPV of Greenhouse = 94,631.25 - 75,000 = 19,631.25

YEAR CASH INFLOWS PVF(12%) PV OF CASHFLOWS CASH INFLOWS PVF(12%) PV OF CASHFLOWS 1 40,000 0.893 35,720 26,250 0.893 23,441.25 2 35,000 0.797 27,895 26,250 0.797 20,921.25 3 22,000 0.712 15,664 26,250 0.712 18,690 4 18,000 0.636 11,448 26,250 0.636 16,695 5 16,250 0.567 9,213.75 26,250 0.567 14883.75 TOTAL PVCI 99,940.75

94,631.25

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