Hearne Company has a number of potential capital investments. Because these proj
ID: 2460502 • Letter: H
Question
Hearne 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.
This project would require an initial investment of $5,150,000. It would generate $919,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,072,000.
The patent would cost $3,610,000, which would be fully amortized over five years. Production of this product would generate $559,550 additional annual net income for Hearne.
Hearne could purchase 25 new delivery trucks at a cost of $145,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,600. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $561,900 of additional net income per year.
Determine each project's accounting rate of return. (Round your answers to 2 decimal places.)
Determine each project's payback period. (Round your answers to 2 decimal places.)
Using a discount rate of 10 percent, calculate the net present value of each project. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Round your intermediate calculations to 4 decimal places and final answers to 2 decimal places.)
Determine the profitability index of each project and prioritize the projects for Hearne. (Round your intermediate calculations to 2 decimal places. Round your final answers to 4 decimal places.)
Hearne 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.
Explanation / Answer
1.
Project 1
Project 2
Project 3
A
Initial investment
$ 5,150,000
$ 3,610,000
$ 3,625,000
B
Salvage value
$ 1,072,000
$ 0
$ 140,000
C
Depreciable base
(A-B)
$ 4,078,000
$ 3,610,000
$ 3,485,000
D
Useful life
$ 8
$ 5
$ 10
E
Annual depreciation
(C/D)
$ 509,750
$ 722,000
$ 348,500
F
Annual income
$ 919,000
$ 559,550
$ 561,900
G
Annual Accounting income
(F-E)
$ 409,250
-$ 162,450
$ 213,400
H
Accounting rate of return
(H/A)
7.95
-4.50
5.89
2.
Project 1
Project 2
Project 3
A
Initial investment
$ 5,150,000
$ 3,610,000
$ 3,625,000
B
Annual income
$ 919,000
$ 559,550
$ 561,900
C
Payback period (years)
(A/B)
5.60
6.45
6.45
3.
Present value of annuity factor = {1 – (1+r)-n}/r
Present value factor = 1 / (1+r)n
Project 1
Project 2
Project 3
A
Initial investment
$ 5,150,000
$ 3,610,000
$ 3,625,000
B
Annual income
$ 919,000
$ 559,550
$ 561,900
C
Useful life
8
5
10
C
Present value of annuity factor
5.3349
3.7908
6.1446
D
Present value of annual cash inflows
$ 4,902,773
$ 2,121,142
$ 3,452,651
E
Salvage Value
$ 1,072,000
$ 0
$ 140,000
F
Present value factor
0.4665
0.6209
0.3855
G
Present value of salvage value
$ 500,088
$ 0
$ 53,970
H
Net present value
(-A+D+H)
$ 252,861
-$ 1,488,858
-$ 118,379
4.
Project 1
Project 2
Project 3
A
Present value of annual cash inflows
$ 4,902,773.10
$ 2,121,142.14
$ 3,452,650.74
B
Present value of salvage value
$ 500,088.00
$ 0.00
$ 53,970.00
C
Present value of future cash flows
(A+B)
$ 5,402,861.10
$ 2,121,142.14
$ 3,506,620.74
D
Initial investment
$ 5,150,000.00
$ 3,610,000.00
$ 3,625,000.00
E
Profitability index
(C/D)
1.05
0.59
0.97
Project 1
Project 2
Project 3
A
Initial investment
$ 5,150,000
$ 3,610,000
$ 3,625,000
B
Salvage value
$ 1,072,000
$ 0
$ 140,000
C
Depreciable base
(A-B)
$ 4,078,000
$ 3,610,000
$ 3,485,000
D
Useful life
$ 8
$ 5
$ 10
E
Annual depreciation
(C/D)
$ 509,750
$ 722,000
$ 348,500
F
Annual income
$ 919,000
$ 559,550
$ 561,900
G
Annual Accounting income
(F-E)
$ 409,250
-$ 162,450
$ 213,400
H
Accounting rate of return
(H/A)
7.95
-4.50
5.89
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