Need answers for parts 5, 7 and 8. Capital Rationing Decision for a Service Comp

Question

Need answers for parts 5, 7 and 8.

Capital Rationing Decision for a Service Company Involving Four Proposals

Clearcast Communications Inc. 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 12% and the present value of $1 table above. Round to the nearest dollar.

Note: Select the proposals in alphabetic order.

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

Note: Select the proposals in alphabetic order.

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 ____ has the larger net present value, it is not as attractive as Proposal ___ in terms of the amount of present value per dollar invested. Proposal ___requires the larger investment. Thus, management should use investment resources for Proposal ___before investing in Proposal ___, absent any other qualitative considerations that may impact the decision.

Investment Year Income from Operations Net Cash Flow Proposal A: $450,000 1 $ 30,000 $ 120,000 2    30,000    120,000 3    20,000    110,000 4    10,000    100,000 5    (30,000)      60,000 $ 60,000 $510,000 Proposal B: 200,000 1 $ 60,000 $ 100,000 2    40,000     80,000 3      20,000     60,000 4      (10,000)        30,000 5 (20,000)     20,000 $ 90,000 $290,000 Proposal C: $320,000 1 $ 36,000 $ 100,000 2    26,000    90,000 3    26,000    90,000 4    16,000    80,000 5    16,000    80,000 $120,000 $ 440,000 Proposal D: $540,000 1 $92,000 $ 200,000 2   72,000    180,000 3    52,000    160,000 4    12,000    120,000 5 (8,000)        100,000 $220,000 $     760,000

Explanation / Answer

5.

Present value index = Present value of net cash flows/Initial investment

Proposal B: $226200/$200000 = 1.13

Proposal D: $569000/$540000 = 1.05

7.

8. The present value indexes indicate that although Proposal D has the larger net present value, it is not as attractive as Proposal B 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 D before investing in Proposal B, absent any other qualitative considerations that may impact the decision.  

Note: The present value of cash flows given in part 4 has been assumed to be correct and used for calculating the present value index. The correctness of the same has not been re-verified.

Select proposal to compute Present value index Proposal B Proposal D Present value index (rounded) 1.13 1.05

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