Capital Rationing Decision for a Service Company Involving Four Proposals Clearc

Question

Capital Rationing Decision for a Service Company Involving Four Proposals Clearcast Communications Inc. is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated income fronm operations, and net cash flow for each proposal are as follows: Income from Operations 30,000 30,000 20,000 10,000 (30,000) 60,000 60,000 40,000 20,000 (10,000) (20,000) $90,000 $ 36,000 26,000 26,000 16,000 16,000 $120,000 Net Caslh Flow Investment Year $120,000 120,000 110,000 100,000 60,000 $510,000 $100,000 80,000 60,000 30,000 20,000 $290,000 $100,000 90,000 90,000 80,000 80,000 $440,000 Proposal A: $450,0001 2 4 Proposal B $200,000 1 2 4 Proposal C: $320,000 1 2 4

Explanation / Answer

1)

Cash Payback Period

Proposal A = 4 years

Proposal B = 2 + 20000/60000 = 2.33 years

Proposal C = 3 + 40000/80000 = 3.50 years

Proposal D = 3 years

Working

2)

Proposal A

Average Rate of return = Average Net Income/Average Net Investment

Average Net Income = Total Income/5

Average Net Income = 60000/5

Average Net Income = 12000

Average Net Investment = (Initial Investment + Salvage Value)/2

Average Net Investment = (450000+0)/2

Average Net Investment = 225000

Average Rate of return = 12000/225000

Average Rate of return = 5.33%

Proposal B

Average Rate of return = Average Net Income/Average Net Investment

Average Net Income = Total Income/5

Average Net Income = 90000/5

Average Net Income = 18000

Average Net Investment = (Initial Investment + Salvage Value)/2

Average Net Investment = (200000+0)/2

Average Net Investment = 100000

Average Rate of return = 18000/100000

Average Rate of return = 18%

Proposal C

Average Rate of return = Average Net Income/Average Net Investment

Average Net Income = Total Income/5

Average Net Income = 120000/5

Average Net Income = 24000

Average Net Investment = (Initial Investment + Salvage Value)/2

Average Net Investment = (320000+0)/2

Average Net Investment = 160000

Average Rate of return = 24000/160000

Average Rate of return = 15%

Proposal C

Average Rate of return = Average Net Income/Average Net Investment

Average Net Income = Total Income/5

Average Net Income = 220000/5

Average Net Income = 44000

Average Net Investment = (Initial Investment + Salvage Value)/2

Average Net Investment = (540000+0)/2

Average Net Investment = 270000

Average Rate of return = 44000/270000

Average Rate of return = 16.30%

3)

Proposal A Proposal B Proposal C Proposal D Year Cash Flow Cumulative Cash Flow Cash Flow Cumulative Cash Flow Cash Flow Cumulative Cash Flow Cash Flow Cumulative Cash Flow 0 -450000 -450000 -200000 -200000 -320000 -320000 -540000 -540000 1 120000 -330000 100000 -100000 100000 -220000 200000 -340000 2 120000 -210000 80000 -20000 90000 -130000 180000 -160000 3 110000 -100000 60000 40000 90000 -40000 160000 0 4 100000 0 30000 70000 80000 40000 120000 120000 5 60000 60000 20000 90000 80000 120000 100000 220000

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