Capital Rationing Decision for a Service Company Involving Four Proposals Renais

Question

Capital Rationing Decision for a Service Company Involving Four Proposals

Renaissance Capital Group is considering allocating a limited amount of capital investment funds among four proposals. The amount of proposed investment, estimated income from operations, and net cash flow for each proposal are as follows:

The company's capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average rate of return of 12% is required on all projects. If the preceding standards are met, the net present value method and present value indexes are used to rank the remaining proposals.

Required:

1. Compute the cash payback period for each of the four proposals.

2. Giving effect to straight-line depreciation on the investments and assuming no estimated residual value, compute the average rate of return for each of the four proposals. If required, round your answers to one decimal place.

3. Using the following format, summarize the results of your computations in parts (1) and (2) by placing the calculated amounts in the first two columns on the left and indicate which proposals should be accepted for further analysis and which should be rejected. If required, round your answers to one decimal place.

4. For the proposals accepted for further analysis in part (3), compute the net present value. Use a rate of 15% and the present value of $1 table above. Round to the nearest dollar.

5. Compute the present value index for each of the proposals in part (4). If required, round your answers to two decimal places.

6. Rank the proposals from most attractive to least attractive, based on the present values of net cash flows computed in part (4).

7. Rank the proposals from most attractive to least attractive, based on the present value indexes computed in part (5).

8. The present value indexes indicate that although Proposal D has the larger net present value, it is not as attractive as Proposal C in terms of the amount of present value per dollar invested. Proposal D requires the larger investment. Thus, management should use investment resources for Proposal C before investing in Proposal D , absent any other qualitative considerations that may impact the decision.

Investment Year Income from Operations Net Cash Flow Proposal A: $680,000 1 $ 64,000 $ 200,000 2    64,000    200,000 3    64,000    200,000 4    24,000    160,000 5    24,000    160,000 $240,000 $ 920,000 Proposal B: $320,000 1 $ 26,000 $ 90,000 2    26,000     90,000 3      6,000     70,000 4      6,000     70,000 5 (44,000)     20,000 $ 20,000 $340,000 Proposal C: $108,000 1 $ 33,400 $ 55,000 2    31,400    53,000 3    28,400    50,000 4    25,400    47,000 5    23,400    45,000 $142,000 $ 250,000 Proposal D: $400,000 1 $100,000 $ 180,000 2   100,000    180,000 3    80,000    160,000 4    20,000    100,000 5 0        80,000 $300,000 $700,000

Explanation / Answer

Solution 1:

Cash payback period proposal A = 3 years + ($760,000 - $680,000) / $160,000 = 3.5 years or 3 years, 6 months

Cash payback period Proposal B = 4 years

Cash payback period Proposal C = 2 Years

Cash payback period Proposal D = 2 Years + ($400,000 - $360,000) / $160,000 = 2.25 years or 3 year and 3 months

Solution 2:

Average rate of return = Average annual income / Average investment

Average investment:

Proposal A = ($680,000 + $0) / 2 = $340,000

Proposal B = ($320,000 + $0 ) /2 = $160,000

Proposal C = ($108,000 + $0) / 2 = $54,000

Proposal D = ($400,000 + $0) /2 = $200,000

Average Income:

Proposal A = $240,000 / 5 = $48,000

Proposal B = $20,000 / 5 = $4,000

Proposal C = $142,000 / 5 = $28,400

Proposal D = $300,000 / 5 = $60,000

Average rate of return:

Proposal A = $48,000 / $340,000 = 14.1%

Proposa B = $4,000 / $160,000 = 2.5%

Proposal C = $28,400 / $54,000 = 52.6%

Proposal D = $60,000 / $200,000 = 30%

Solution 3:

Solution 4:

Solution 5:

Note: As per chegg policy i have answered sufficent parts, Kindly post separate question for answer of remaining parts.

Computation of Cumulative Cash Inflows Year Proposal A Proposal B Proposal C Proposal D Cash inflows Cumulative Cash Inflows Cash inflows Cumulative Cash Inflows Cash inflows Cumulative Cash Inflows Cash inflows Cumulative Cash Inflows 1 $200,000.00 $200,000.00 $90,000.00 $90,000.00 $55,000.00 $55,000.00 $180,000.00 $180,000.00 2 $200,000.00 $400,000.00 $90,000.00 $180,000.00 $53,000.00 $108,000.00 $180,000.00 $360,000.00 3 $200,000.00 $600,000.00 $70,000.00 $250,000.00 $50,000.00 $158,000.00 $160,000.00 $520,000.00 4 $160,000.00 $760,000.00 $70,000.00 $320,000.00 $47,000.00 $205,000.00 $100,000.00 $620,000.00 5 $160,000.00 $920,000.00 20000 $340,000.00 $45,000.00 $250,000.00 $80,000.00 $700,000.00

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