Question

Average Rate of Return Method, Net Present Value Method, and Analysis for a service company

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
Year	Income from Operations		Net Cash Flow			Income from Operations		Net Cash Flow
1	$65,100		$209,000			$137,000		$334,000
2	65,100		209,000			104,000		282,000
3	65,100		209,000			52,000		199,000
4	65,100		209,000			23,000		136,000
5	65,100		209,000			9,500		94,000
Total	$325,500		$1,045,000			$325,500		$1,045,000

Each project requires an investment of $620,000. 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
Year	6%	10%	12%	15%	20%
1	0.943	0.909	0.893	0.870	0.833
2	0.890	0.826	0.797	0.756	0.694
3	0.840	0.751	0.712	0.658	0.579
4	0.792	0.683	0.636	0.572	0.482
5	0.747	0.621	0.567	0.497	0.402
6	0.705	0.564	0.507	0.432	0.335
7	0.665	0.513	0.452	0.376	0.279
8	0.627	0.467	0.404	0.327	0.233
9	0.592	0.424	0.361	0.284	0.194
10	0.558	0.386	0.322	0.247	0.162

Required:

1a. Compute the average rate of return for each investment. If required, round your answer to one decimal place.

	Average Rate of Return
Front-End Loader	%
Greenhouse	%

1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, use the minus sign to indicate a negative net present value.

	Front-End Loader	Greenhouse
Present value of net cash flow	$	$
Amount to be invested	$	$
Net present value	$	$

2. Prepare a brief report for the capital investment committee, advising it on the relative merits of the two investments.

The front-end loader has a net present value because cash flows occur in time compared to the greenhouse. Thus, if only one of the two projects can be accepted, the would be the more attractive.

Answer 1

			Fron end	green house
Total income from Operations			325500	325500
Divide: Life			5	5
Average income			65100	65100
Divide: Average investment			310000	310000
	(620000/2)
Average rate of return			21%	21%
NPV		Front end		Greenhoouse
Year	PVF at 10%	CF	Present value	Cf	Present value
0	1	-620000	-620000	-620000	-620000
1	0.909	209000	189981	334000	303606
2	0.826	209000	172634	282000	232932
3	0.751	209,000	156959	199000	149449
4	0.683	209000	142747	136000	92888
5	0.621	209000	129789	94000	58374
Net present value			172110		217249
The fron end loader has lower net present value because a cash flows occur later in time comared to Grrenhouse.
Thus is any one of the two projects can be accepted, the Greehouse would be more attractive.