L List , Explain and give advantages and disadvantages of the following methods
ID: 2816675 • Letter: L
Question
L
List , Explain and give advantages and disadvantages of the following methods
a.Pay back Period
b.Accounting Rate of Return
c.Net Present Value
d.Profitability Index
e.Internal Rate of Return
Simply Chocolate Company is considering two possible expansion plans.Proposal X involves opening five stores in North Carolina at a cost of $2,400,000. Under Proposal Y, the company would focus on Virginia and open six stores at a cost of $3,000,000. The following information is given for the two proposals:
Proposal XProposal Y
Required investment$2,400,000$3,000,000
Estimated life10 years10 years
Estimated residual value$200,000$200,000
Estimated annual net cash flows$450,000$580,000
Required rate of return14%14%
Based on the above following problem,
Required: for each proposal, you are asked tocalculate
Pay back Period
Accounting Rate of Return
Net Present Value
Profitability Index
Indicate which proposal is the better investment.
Explanation / Answer
Internal Rate of Return:
Advanatges: COnsiders time value of money
Disadvanatges: Sometimes Gives conflicting rankings and difficult to use
Payback Period:
Advantages:Easy to calculate
Disadvantages:Ignores time value of money
Proposal X=2400000/450000=5.33 years
Proposal X=3000000/580000=5.172 years
Depreciation for Proposal X=(2400000-200000)/10=220000
Depreciation for Proposal Y=(3000000-200000)/10=280000
Accounting rate of return:
Proposal X=(450000-220000)/2400000=9.5833%
Proposal Y=(580000-280000)/3000000=10%
Net Present Value:
Advantages: Considers time value of money
Disadvantages: Difficult to use
Proposal X=-2400000+450000/0.14*(1-1/1.14^10)+200000/1.14^10=1200.803
Proposal Y=-3000000+580000/0.14*(1-1/1.14^10)+200000/1.14^10=79295.84
Profitability Index:
Advantages: Considers all cash flows and also considers time value of money
Disadvanatges: Sometimes gives COnflicting decisions while Comparison of mjutually exclusive projects
Proposal X=1+1200.803/2400000=1.0005
Proposal Y=1+79295.84/3000000=1.026432
Proposal Y is the better investment
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