Question

Average Rate of Return Method, Net Present Value Method, and Analysis

The capital investment committee of Ellis Transport and Storage Inc. is considering two investment projects. The estimated income from operations and net cash flows from each investment are as follows:

	Warehouse					Tracking Technology
Year	Income from Operations		Net Cash Flow			Income from Operations		Net Cash Flow
1	$36,100		$118,000			$76,000		$189,000
2	36,100		118,000			58,000		159,000
3	36,100		118,000			29,000		112,000
4	36,100		118,000			13,000		77,000
5	36,100		118,000			4,500		53,000
Total	$180,500		$590,000			$180,500		$590,000

Each project requires an investment of $380,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% 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
Warehouse	%
Tracking Technology	%

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.

	Warehouse	Tracking Technology
Present value of net cash flow total	$	$
Less amount to be invested	$	$
Net present value	$	$

2. The warehouse has a   net present value as tracking technology cash flows occur   in time. Thus, if only one of the two projects can be accepted, the   would be the more attractive.

Answer 1

Solution 1a:

Average rate of return = Average annual income / Average investment

Average annual income:

Warehouse = $180,500 / 5 = $36,100

Tracking technology = $180,500 / 5 = $36,100

Average investment:

Warehouse = ($380,000 + 0) / 2 = $190,000

Tracking technology = ($380,000 + 0) / 2 = $190,000

Average rate of return:

Warehouse = $36,100 / $190,000 = 19%

Tracking technology = $36,100 / $190,000 = 19%

Solution 1b:

Computation of NPV
			Warehouse		Tracking Technology
Particulars	Period	PV Factor	Amount	Present Value	Amount	Present Value
Cash outflows:
Cost of Equipment	0	1	$380,000	$380,000	$380,000	$380,000
Present Value of Cash outflows (A)				$380,000		$380,000
Cash Inflows
Year 1	1	0.870	$118,000	$102,660	$189,000	$164,430
Year 2	2	0.756	$118,000	$89,208	$159,000	$120,204
Year 3	3	0.658	$118,000	$77,644	$112,000	$73,696
Year 4	4	0.572	$118,000	$67,496	$77,000	$44,044
Year 5	5	0.497	$118,000	$58,646	$53,000	$26,341
Present Value of Cash Inflows (B)				$395,654		$428,715
Net Present Value (NPV) (B-A)				$15,654		$48,715

Solution 2:

The warehouse has a lower net present value as tracking technology cash flows occur earlier in time. Thus, if only one of the two projects can be accepted, the tracking technology would be the more attractive