Average Rate of Return Method, Net Present Value Method, and Analysis The capita

Question

Average Rate of Return Method, Net Present Value Method, and Analysis The capital investment committee of Cross Continent Trucking Inc. 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 $520,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 10% for purposes of the net present value analysis.

Required:

1a. Compute the average rate of return for each investment. If required, round your answer to one decimal place.

1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, use the minus sign to indicate a negative net present value.

2. The warehouse has a net present value because cash flows occur earlier in time compared to the tracking technology. Thus, if only one of the two projects can be accepted, the would be the more attractive.

Warehouse Tracking Technology Year Income from
Operations Net Cash
Flow Income from
Operations Net Cash
Flow 1 $39,000 $121,000 $82,000 $194,000 2 39,000 121,000 62,000 163,000 3 39,000 121,000 31,000 115,000 4 39,000 121,000 14,000 79,000 5 39,000 121,000 6,000 54,000 Total $195,000 $605,000 $195,000 $605,000

Explanation / Answer

Answer 1 a.

Warehouse

Annual Rate of Return = Income from Operation / Investment

= 39,000 / 520,000 = 7.5%

Average Rate of return = 7.5%

Tracking Tachnology

Rate of return Year 1 = 15.77%

Rate of return Year 2 = 11.92%

Rate of return Year 3 = 5.96%

Rate of return Year 4 = 2.69%

Rate of return Year 5 = 1.15%

Average Rate of Return = (15.77 + 11.92 + 5.96 + 2.69 + 1.15) / 5

= 7.5%

Answer 1 b.

Warehouse

Present Value of Net Cash Flow = 121,000*0.909 + 121,000*0.826 + 121,000*0.751 + 121,000*0.683 + 121,000*0.621

= $458,590

Net Present Value = - 520,000 + 458,590 = $ - 61,410

Tracking Technology

Present Value of Net Cash Flow = 194,000*0.909 + 163,000*0.826 + 115,000*0.751 + 79,000*0.683 + 54,000*0.621

= $484,840

Net Present Value = - 520,000 + 484,840 = $ - 35,160

Answer 2.

The Warehouse has a low NPV because smaller cash flows occur earlier in time compared to the tracking methodology. Thus, if only one of the two projects can be accepted, the tracking technology would be the more attractive.

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