The capital investment committee of Arches Landscaping Company is considering tw

Question

The capital investment committee of Arches Landscaping Company is considering two capital investments. The estimated income from operations and net cash flows from each investment are as follows Front-End Loader Greenhouse Income from Net Cash Flow Income from Net Cash Year Operations Operations Flow $27,600 27,600 27,600 27,600 27,600 $138,000 $85,000 85,000 85,000 85,000 85,000 $425,000 $58,000 44,000 22,000 10,000 4,000 $138,000 $136,000 115,000 81,000 55,000 38,000 $425,000 Total Each project requires an investment of $460,000. 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. Present Value of $1 at Compound Interest 20% 0.833 0.694 0.840 0.751 0.712 0.658 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 Year 6% 15% 0.870 26 0.797 0.756 12% 10% 0.943 0.909 0.890 0.826 0.893 0.636 0.567 0.705 0.564 0.507 0.452 0.627 0.467 0.404 0.361 0.322 0.572 0.497 0.432 0.376 0.327 0.284 0.247 0.792 0.683 0.747 0.621 0.665 0.513 0.592 0.424 10 0.558 0.386

Explanation / Answer

Solution 1a:

Average rate of return = Average income / Average investment

Average investment = (Initial investment + Salvage value) / 2

Average investment - Front end loader = ($460,000 + $0) / 2 = $230,000

Average investment - Greenhouse = ($460,000 + $0) / 2 = $230,000

Average Annual income - Front end loader = $138,000 / 5 = $27,600

Average Annual income - Green house = $138,000 / 5 = $27,600

Average rate of return - Front end loader = $27,600 / $230,000 = 12%

Average rate of return - Green House = $27,600 / $230,000 = 12%

Solution 1b:

Solution 2:

The front end loader has a lesser NPV because Lower cash flows occur earlier in time compared to the greenhouse. Thus if only of the two projects cah be accepted, the greenhouse would be the more attractive.

Computation of Present Value of cash Inflows Particulars Period PV factor Frontend loader Greenhouse Amount Present Value Amount Present Value Cash inflows: Year 1 1 0.909 $85,000.00 $77,265.00 $136,000.00 $123,624.00 Year 2 2 0.826 $85,000.00 $70,210.00 $115,000.00 $94,990.00 Year 3 3 0.751 $85,000.00 $63,835.00 $81,000.00 $60,831.00 Year 4 4 0.683 $85,000.00 $58,055.00 $55,000.00 $37,565.00 Year 5 5 0.621 $85,000.00 $52,785.00 $38,000.00 $23,598.00 Present value of cash inflows $322,150.00 $340,608.00

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