Required: a. Rank these investment proposals using the payback period, the accou
ID: 2481884 • Letter: R
Question
Required:
a. Rank these investment proposals using the payback period, the accounting rate of return on initial investment, and the net present value criteria. Assume that the organization’s cost of capital is 12 percent. Round calculations to four decimal places.
b. Explain the differences in rankings. Which proposal would you recommend and why?
Proposal A Proposal B Proposal C Initial Investment $67,500 $67,500 $67,500 Cash Flow from operations Year 1 60,000 33,750 67,500 Year 2 7,500 33,750 0 Year 3 33,750 33,750 0 Disinvestment 0 0 0 Life (years) 3 years 3 years 1 yearExplanation / Answer
Proposal A Cash Flow comm casf flow Year 0 investment -67500 -67500 Year 1 cash inflow 60000 -7500 Year 2 cash inflow 7500 0 Year 3 cash inflow 33750 33750 Total cash inflow 101250 Payback period = 2 years 0.50 Average cash inflow = 101250 / 3 = 33750 Accounting rate of return = average cash inflow / initial investment = 33750 / 67500 = 50% NPV = CF1/(1+r)1+ CF2/(1+r)2 + CF3/(1+r)3 - initial investment = 60000 /(1+0.12) + 7500 /(1+0.12)2 + 33750 /(1+0.12)3 - 67500 = 60000/1.12 + 7500/1.2544 + 33750 / 1.4049 - 67500 = 53571.43+ 5978.95 + 24023.06 - 67500 = 16073.44 Proposal B Cash Flow comm casf flow Year 0 investment -67500 -67500 Year 1 cash inflow 33750 -33750 Year 2 cash inflow 33750 0 Year 3 cash inflow 33750 33750 Total cash inflow 101250 Payback period = 2 years Average cash inflow = 101250 / 3 = 33750 Accounting rate of return = average cash inflow / initial investment = 33750 / 67500 = 50% NPV = CF1/(1+r)1+ CF2/(1+r)2 + CF3/(1+r)3 - initial investment = 33750 /(1+0.12) + 33750 /(1+0.12)2 + 33750 /(1+0.12)3 - 67500 = 33750/1.12 + 33750/1.2544 + 33750 / 1.4049 - 67500 = 30133.93+ 26905.29 + 24023.06 - 67500 = 13562.28 Proposal C Cash Flow comm casf flow Year 0 investment -67500 -67500 Year 1 cash inflow 67500 0 Year 2 cash inflow 0 0 Year 3 cash inflow 0 0 Total cash inflow 67500 Payback period = 1 year Average cash inflow = 67500 Accounting rate of return = average cash inflow / initial investment = 67500 / 67500 = 100% NPV = CF1/(1+r)1 - initial investment = 67500 /(1+0.12) - 67500 = 67500/1.12 - 67500 = 60267.86 - 67500 = -7232.14 Proposal A Proposal B Proposal C Payback period ( years) 2 2 1 ARR 50% 50% 100% NPV 16073.44 13562.28 -7232.14 Ranking 1 2 3 The reason for Proposal A to be 1st is because the NPV is the highest and ARR is greater than the required rate of return The reason Proposal B is 2nd is because the NPV is lower than Proposal A The reason proposal C is 3rd is because NPV is negative
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