Heane Company has a number of potential capital investments. Because these proje

Question

Heane Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them. Assume straight line depreciation method is used Project 1: Retooling Manufacturing Facility This project would require an initial investment of $4,950,000. It would generate $883,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,024,000. Project 2: Purchase Patent for New Product The patent would cost $3,470,000, which would be fully amortized over five years. Production of this product would generate $468,450 additional annual net income for Hearne. Project 3: Purchase a New Fleet of Delivery Trucks Hearne could purchase 25 new delivery trucks at a cost of $125,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,200. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $421,900 of additional net income per year. Required 1. Determine each project's accounting rate of return. (Round your answers to 2 decimal places.) Accounting Rate of Return Project 1 Project 2 Project 3

Explanation / Answer

Determination of project's accounting rate of return Additional cash flow Depreciation Net return-A Initial investment Salvage Value Net Investment-B Accounting Rate of return=A/B% Project 1 883000 490750 392250 4950000 1024000 3926000 9.99 Project 2 468450 694000 -225550 3470000 0 3470000 -6.50 Project 3 421900 299500 122400 3125000 130000 2995000 4.09 Determination of each project's Payback period Project 1 Project 2 Project 3 Net Cash flow Net Cash flow Net Cash flow Year 0 -4950000 -3470000 -3125000 1 883000 468450 421900 2 883000 468450 421900 3 883000 468450 421900 4 883000 468450 421900 5 883000 468450 421900 6 883000 421900 7 883000 421900 8 883000 421900 9 883000 421900 10 883000 421900 5 Years & 7.27 Months 7 years & 4.88 Months 3 Net present Value Project 1 Project 2 Project 3 Net Cash flow Net Cash flow Net Cash flow Year PVIF@10% Present Value PVIF@10% Present Value PVIF@10% Present Value 0 -4950000 1 -4950000 -3470000 1 -3470000 -3125000 1 -3125000 1 883000 0.909091 802727.3 468450 0.909091 425863.6 421900 0.909091 383545.5 2 883000 0.826446 729752.1 468450 0.826446 387148.8 421900 0.826446 348677.7 3 883000 0.751315 663411 468450 0.751315 351953.4 421900 0.751315 316979.7 4 883000 0.683013 603100.9 468450 0.683013 319957.7 421900 0.683013 288163.4 5 883000 0.620921 548273.5 468450 0.620921 290870.6 421900 0.620921 261966.7 6 883000 0.564474 498430.5 421900 0.564474 238151.6 7 883000 0.513158 453118.6 421900 0.513158 216501.4 8 883000 0.466507 411926 421900 0.466507 196819.5 9 883000 0.424098 374478.2 421900 0.424098 178926.8 10 883000 0.385543 340434.7 421900 0.385543 162660.7 10 1024000 0.385543 394796.3 130000 0.385543 50120.63 Net present Value 870449.1 Net present Value -1694206 Net present Value -482487 4 Profitability Index =Total present Value of cash inflows/Initial Investment Project 1 Project 2 Project 3 Total present value of cahs inflows 5820449 Total present value of cahs inflows 1775794 Total present value of cahs inflows 2642513 Net Initial Investment 4950000 3470000 3125000 Profitability Index 1.175848 0.511756 0.845604

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