PA11-3 Comparing, Prioritizing Multiple Projects [LO 11-1, 11-2, 11-3, 11-6] Hea
ID: 2591491 • Letter: P
Question
PA11-3 Comparing, Prioritizing Multiple Projects [LO 11-1, 11-2, 11-3, 11-6]
Hearne Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them. Assume straight line depreciation method is used.
Project 1: Retooling Manufacturing Facility
This project would require an initial investment of $5,650,000. It would generate $1,009,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,192,000.
Project 2: Purchase Patent for New Product
The patent would cost $3,960,000, which would be fully amortized over five years. Production of this product would generate $811,800 additional annual net income for Hearne.
Project 3: Purchase a New Fleet of Delivery Trucks
Hearne could purchase 25 new delivery trucks at a cost of $195,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $6,600. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $999,380 of additional net income per year.
Required:
1. Determine each project's accounting rate of return. (Round your answers to 2 decimal places.)
2. Determine each project's payback period. (Round your answers to 2 decimal places.)
3. Using a discount rate of 10 percent, calculate the net present value of each project. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Round your intermediate calculations to 4 decimal places and final answers to 2 decimal places.)
4. Determine the profitability index of each project and prioritize the projects for Hearne. (Round your intermediate calculations to 2 decimal places. Round your final answers to 4 decimal places.)
Explanation / Answer
A / 1 B C D E 2 Particulars Project-1 Project-2 Project-3 3 Initial Investment $5,650,000 $3,960,000 $4,875,000 4 Additional Net cash flow each year $1,009,000 $811,800 $999,380 5 useful life(years) 8 5 10 6 Salvage value $1,192,000 $0 $165,000 7 Depreciation(Straight line) 8 Discount Rate per annum 10% 10% 10% 9 Depreciation amount per annum $557,250 $792,000 $471,000 10 Annual Profit(Additional net cash flow - depreciation) $451,750 $19,800 $528,380 11 12 1. Accounting Rate of Return 13 ARR= Average annual profit / Average investment 14 Average annual profit = $451,750 $19,800 $528,380 15 Average investment = $5,650,000 $3,960,000 $4,875,000 16 Therefore ARR= 8.00% 0.50% 10.84% 17 18 2. Payback period 19 PBP=Initial Investment/Annual cash flow 20 Annual Cashflow $1,009,000 $811,800 $999,380 21 Initial Investment $5,650,000 $3,960,000 $4,875,000 22 Payback period(years) 5.60 4.88 4.88 23 24 3. Net Present Value $289,017.33 -$882,639.30 $1,329,372.12 25 formula used =-PV(C8,C5,C4,C6,0)-C3 =-PV(D8,D5,D4,D6,0)-D3 =-PV(E8,E5,E4,E6,0)-E3 26 27 4. Profitability Index 1.0512 0.7771 1.2727 28 Profitability Index =(NPV+Investment)/Investment
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