Average Rate of Return Method, Net Present Value Method, and Analysis The capita
ID: 2485369 • Letter: A
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 fromOperations 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
1a.
Average annual return for both projects = ($195,000/5)/($520,000+$0) = 0.075 = 7.5%
1b.
Year
Present value factor @ 10%
Warehoue
Tracking technology
Net cash flows
Present value of net cash flows
Net cash flows
Present value of net cash flows
1
0.909
$ 121,000
$ 109,989
$ 194,000
$ 176,346
2
0.826
$ 121,000
$ 99,946
$ 163,000
$ 134,638
3
0.751
$ 121,000
$ 90,871
$ 115,000
$ 86,365
4
0.683
$ 121,000
$ 82,643
$ 79,000
$ 53,957
5
0.621
$ 121,000
$ 75,141
$ 54,000
$ 33,534
Present value of net cash flow total
$ 458,590
$ 484,840
Less amount to be invested
$ 520,000
$ 520,000
Net present value
-$ 61,410
-$ 35,160
2.
The warehouse has a lower net present value because smaller cash flows occur earlier in time compared to the tracking technology. Thus, if only one of the two projects can be accepted, the Tracking technology would be the more attractive.
Year
Present value factor @ 10%
Warehoue
Tracking technology
Net cash flows
Present value of net cash flows
Net cash flows
Present value of net cash flows
1
0.909
$ 121,000
$ 109,989
$ 194,000
$ 176,346
2
0.826
$ 121,000
$ 99,946
$ 163,000
$ 134,638
3
0.751
$ 121,000
$ 90,871
$ 115,000
$ 86,365
4
0.683
$ 121,000
$ 82,643
$ 79,000
$ 53,957
5
0.621
$ 121,000
$ 75,141
$ 54,000
$ 33,534
Present value of net cash flow total
$ 458,590
$ 484,840
Less amount to be invested
$ 520,000
$ 520,000
Net present value
-$ 61,410
-$ 35,160
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