Average rate of return method, net present value method, and analysis for a serv
ID: 2474621 • Letter: A
Question
Average rate of return method, net present value method, and analysis for a service company The capital investment committee of Touch of Eden Landscaping Company is considering two capital investments. The estimated income from operations and net cash flows from each investment are as follows: Each project requires an investment of $60,000. 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. Instructions Compute the following: a. The average rate of return for each investment. Round to one decimal place. The net present value for each investment. Use the present value of $1 table appearing in this chapter (Exhibit 2). Round present values to the nearest dollar. Prepare a brief report for the capital investment committee, advising it on the relative merits of the two investments.Explanation / Answer
Answer of Question 1 Part (a)
Average Rate of Return = (Total Income from Operation – Initial investment) / Initial investment
Average rate of return (Front End Loader) = ($ 51, 000 - $ 60,000) / $ 60,000
= 0 %
Average rate of return (Greenhouse Fixtures) = ($ 51, 000 - $ 60,000) / $ 60,000
= 0 %
Answer of Question 1 Part (b)
Net Present Value = PV of cash inflow – PV of cash outflow
Front End Loader’s NPV :
Year
Income
PV @ 12 %
PV of Income
1
35,000
0.893
31,250.00
2
32,000
0.797
25,510.20
3
24,000
0.712
17,082.73
4
10,000
0.636
6,355.18
5
10,000
0.567
5,674.27
Total
85,872.38
Net Present Value = 85,872.38 – 60,000 = $ 25,872 .38
Greenhouse Fixtures’ NPV :
Year
Income
PV @ 12 %
PV of Income
1
22,200
0.893
19,821.43
2
22,200
0.797
17,697.70
3
22,200
0.712
15,801.52
4
22,200
0.636
14,108.50
5
22,200
0.567
12,596.88
Total
80,026.03
Net Present Value = 80,026.03 – 60,000 = $ 20,026 .03
Answer of Question (2)
Conclusion :
Average rate of return (ARR) of both the proposals are same, since ARR is not more reliable measure for considering a proposal because it ignores time value of money concept. So we should take our decision on the basis of NPV. We should accept Frond End loader’s proposal, since its NPV is more
Year
Income
PV @ 12 %
PV of Income
1
35,000
0.893
31,250.00
2
32,000
0.797
25,510.20
3
24,000
0.712
17,082.73
4
10,000
0.636
6,355.18
5
10,000
0.567
5,674.27
Total
85,872.38
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