Question

Ranking Investment Proposals: Payback Period, Accounting Rate of Return, and Net Present

Value

Presented is information pertaining to the cash flows of three mutually exclusive investment proposals:

............................................................................................Proposal A Propsal B Propsal C

Initial Investment............................................................... 60000 60000 60000

Cash flow from oeprations:   

Year 1 50000 30000 60000

Year 2 6000 30000

Year 3 29000 25000

Disinvestment 0 0 0

Life (years) 3 3 1

Required

a.  Rank these investment proposals using the payback period, the accounting rate of return on initial

investment, and the net present value criteria. Assume that the organization’s cost of capital is 12

percent. Round calculations to four decimal places.

b.  Explain the difference in rankings. Which investment would you recommend?

	Proposal A
Year	Cash flow C	Cumulative cash flow	Discount factor 15% D	Discounted Cash flow D	PV of cash inflow
0	-60000	-60000	1	-60000
1	50000	-10000	0.8929	44645	44645
2	6000	-4000	0.7972	4783.2	4783
3	29000	25000	0.7118	20642.2	20642
			NPV	10070	70070
Payback Period = A +	A+B/c
A is the last period with a negative cumulative cash flow
B is the absolute value of cumulative cash flow at the end of the period A
C is the total cash flow during the period after A
Payback =	2+(4000/29000)	2.14
Accounting rate of return	8333.333/60000*100	13.89
Cash flow from operations -Depreciation to calculate Net Income
Avg Income	8333.333
(50000-20000+6000-20000+29000-20000)/3
Initial Investment	60000
	Proposal B
Year	Cash flow C	Cumulative cash flow	Discount factor 15% D	Discounted Cash flow D
0	-60000	-60000	1	-60000
1	30000	-30000	0.8929	26787
2	30000	0	0.7972	23916
3	25000	25000	0.7118	17795
			NPV	8498
Payback Period = A +	A+B/c
A is the last period with a negative cumulative cash flow
B is the absolute value of cumulative cash flow at the end of the period A
C is the total cash flow during the period after A
Payback =	2
Accounting rate of return	8333.333/60000*100	13.89
Cash flow from operations -Depreciation to calculate Net Income
Avg Income	8333.333
(30000-20000+30000-20000+25000-20000)/3
Initial Investment	60000
	Proposal C
Year	Cash flow C	Cumulative cash flow	Discount factor 15% D	Discounted Cash flow D
0	-60000	-60000	1	-60000
1	60000	0	0.8929	53574
2	0	0	0.7972	0
3	0	0	0.7118	0
			NPV	-6426
Payback Period = A +	A+B/c
A is the last period with a negative cumulative cash flow
B is the absolute value of cumulative cash flow at the end of the period A
C is the total cash flow during the period after A
Payback =	1
Accounting rate of return	0%
(60000-60000)/60000*100
ans 1
	Proposal A	Proposal B	Proposal C	Proposal
Payback period	2.14	2	1	C
ARR	13.89%	13.89%	0	A and B
NPV	10070	8498	-6426	A
ans 2
ARR considers profitability of each proposal while payback considers the time
required to recover the investment made.
The best method is NPV as it takes into account the present value of cash flows.
So according to it Proposal A is best and also ARR is equal for A and B
So best proposal is A

Based on the work for P12-28 a and b, provide answers to the following questions.

Input any numeric answers as a number with commas and round to the nearest dollar. For example enter $11,123.81 as 11,124. If the proposal has a negative NPV input the answer as a (11,124).

Net Present Value for Proposal A is?

Net Present Value for Proposal B is:?

Net Present Value for Proposal C is?

Based on the work for P12-28 a and b, provide answers to the following questions.

Input any PI answers as a number with two decimals. For example, a PI of 1.234 should be recorded as 1.23

Profitability Index for Proposal A is:?

Profitability Index for Proposal B is:?

Profitability Index for Proposal C is:?

Based on the work for P12-28 a and b, answer the following question.

Which proposal (A, B or C) would you recommend given the answers above and why?

		Proposal C is best because it yields the largest operating cash inflows for year 1.
		Proposal A is best because the Profitability Index is highest.
		Proposal B is best because it yields the most consistent annual cash inflows of the 3 proposals.

Answer 1

profitability Index for the 3 projects are calculated below

Project	Present Value of Cash flow	Initial Investment	Profitability Index	Ranking Of the Project
A	70070	60000	1.17	1
B	68498	60000	1.14	2
C	53574	60000	0.89	3

Profitability index is calculated by dividing presnet value of cashflows by Initial Investment, Here present value of Cashflows are already calulated, we are just copying it.

Recomendation of the project.

A project should be recommended for the investors only on the base of what mentality they are,

if the investors are risk avears it is better to choose project which gives the initial investment in early years which means shprt paybck period projects. which is Project  C

If the investors are More looking for a constant cashflow each year it is better to choose Project B, Which will help them to budgeting and forcasting.

If investors are risk Takers Project A would be the better to choose, Which gives more Profitabilty than others.