Question

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Excess Present Value Index and Average Rate of Return Highpoint Company is evaluating five different capital...

Excess Present Value Index and Average Rate of Return
Highpoint Company is evaluating five different capital expenditure proposals. The company's hurdle rate for net present value analyses is 12%. A 10% salvage value is expected from each of the investments. Information on the five proposals is as follows:

Proposal Required Investment PV at 12% of After-Tax Cash Flows Avg. Annual Net Income from Investment

A

$285,000 $325,030 $37,400

B

215,000 251,780 26,000

C

175,000 188,040 19,200

D

195,000 231,300 27,600

E

143,000 151,990 14,960

a. Compute the excess present value index for each of the five proposals.
Round answers to three decimal places.

Proposal Excess PV Index

A

Answer

B

Answer

C

Answer

D

Answer

E

Answer

b. Compute the average rate of return for each of the five proposals.
Round answers to one decimal place. For example, 0.4567 equals 45.7%

Proposal Avg. Rate of Return

A

Answer

B

Answer

C

Answer

D

Answer

E

Answer


c. Assume that Highpoint will commit no more than $500,000 to new capital expenditure proposals.

Using the excess present value index, which proposals would be accepted. Select the best answer.

AnswerProposals A and BProposals B and EProposals B and DProposals C and EProposals A and D

Now using the average rate of return, which proposals would be accepted? Select the best answer.

AnswerProposals A and BProposals B and EProposals B and DProposals C and EProposals A and D

Solutions

Expert Solution

The part a) is solved below:

Proposal Required investment (A) PV at 12% of After-Tax Cash (B) Profitability index (B/A)
A $285,000 $325,030 1.14
B $215,000 $251,780 1.17
C $175,000 $188,040 1.07
D $195,000 $231,300 1.19
E $143,000 $151,990 1.06

The part b) is solved below:

Proposal Avg. Annual Net Income (A) Average investment (B) Avg. Rate of Return (A/B)
A $37,400 $156,750 23.86%
B $26,000 $118,250 22%
C $19,200 $96,250 19.95%
D $27,600 $107,250 25.73%
E $14,960 $78,650 19.02%

Average investment = (Investment cost + Salvage value) / 2

A = $285,000 * (1 + 10%) / 2 = $156,750

B = $215,000 * (1 + 10%) / 2 = $11,8250

A = $175,000 * (1 + 10%) / 2 = $96,250

A = $195,000 * (1 + 10%) / 2 = $107,250

A = $143,000 * (1 + 10%) / 2 = $78,650

Part c) Assuming that Highpoint will commit no more than $500,000 to new capital expenditure proposals,

Using the PI index, Project B and D should be taken up.

Using the average rate of return, Project A and D should be taken up.


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