In: Accounting
The capital investment committee of Cross Continent Trucking Inc. is considering two capital investments. 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 | $50,400 | $163,000 | $106,000 | $261,000 | ||||||
2 | 50,400 | 163,000 | 81,000 | 220,000 | ||||||
3 | 50,400 | 163,000 | 40,000 | 155,000 | ||||||
4 | 50,400 | 163,000 | 18,000 | 106,000 | ||||||
5 | 50,400 | 163,000 | 7,000 | 73,000 | ||||||
Total | $252,000 | $815,000 | $252,000 | $815,000 |
Each project requires an investment of $560,000. 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 because cash flows occur earlier in time compared to the tracking technology. Thus, if only one of the two projects can be accepted, the would be the more attractive.
Solution 1a:
Average rate of return = Average annual income / Average investment
Average investment = (Cost + Salvage value) / 2
= ($560,000 + 0) / 2 = $280,000
Average annual income:
Warehouse = $252,000 / 5 = $50,400
Tracking Technology = $252,000 / 5 = $50,400
Average rate of return:
Warehouse = $50,400 / $280,000= 18%
Tracking Technology = $50,400 / $280,000= 18%
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 | $560,000 | $560,000 | $560,000 | $560,000 |
Present Value of Cash outflows (A) | $560,000 | $560,000 | ||||
Cash Inflows | ||||||
Year 1 | 1 | 0.870 | $163,000 | $141,810 | $261,000 | $227,070 |
Year 2 | 2 | 0.756 | $163,000 | $123,228 | $220,000 | $166,320 |
Year 3 | 3 | 0.658 | $163,000 | $107,254 | $155,000 | $101,990 |
Year 4 | 4 | 0.572 | $163,000 | $93,236 | $106,000 | $60,632 |
Year 5 | 5 | 0.497 | $163,000 | $81,011 | $73,000 | $36,281 |
Present Value of Cash Inflows (B) | $546,539 | $592,293 | ||||
Net Present Value (NPV) (B-A) | -$13,461 | $32,293 |
Solution 2:
Tracking technology has a higher net present value than warehouse because cash flow occur higher in initial time as compared to tracking technology. Thus if only one of the two projects can be accepted, then tracking technology will be more attractive.