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 $380,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% 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.

Warehouse Tracking Technology Year Income from
Operations Net Cash
Flow Income from
Operations Net Cash
Flow 1 $38,000 $117,000 $80,000 $187,000 2 38,000 117,000 61,000 158,000 3 38,000 117,000 30,000 111,000 4 38,000 117,000 13,000 76,000 5 38,000 117,000 6,000 53,000 Total $190,000 $585,000 $190,000 $585,000

Explanation / Answer

Answer:

Average Rate of Return or Accounting Rate of Return; is a method of analyses that considers the accounting profits as the basis for calculation of return on investment and it ignores time value of money. It is calculated as follows;

ARR = Average Annual Accounting Profit / Initial Investment

In the given question we assume that the figures for Income from Operations are after depreciation and therefore, ARR for the two projects is as under;

Warehouse; ARR = ($ 190,000 x 1/4) / $ 380,000 = 12.5%

Tracking Technology, ARR = ($ 190,000 x 1/4) / $ 380,000 = 12.5%

Net Present Value = Present Value of Cash Inflows - Present Value of Cash Outflows

In the given question since there is no taxation therefore, we ignore depreciation for NPV Calculations.

Warehouse, NPV = $ 117,000 x PVAF@15%, 5 years - $ 380,000 = $ 117,000 x 3.352 - $ 380,000 = $ 392,202 - $ 380,000 = $ 12,202

Tracking Technology, NPV = [($ 187,000 x 0.870) + ($ 158,000 x 0.756) + ($ 111,000 x 0.658) + ($ 76,000 x 0.572) + ($ 53,000 x 0.497)] - $ 380,000 = $ 424,867 - $ 380,000 = $ 44,867

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