Hearne Company has a number of potential capital investments. Because these projects vary in nature, initial...

Hearne Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them. Assume straight line depreciation method is used.

Project 1: Retooling Manufacturing Facility

This project would require an initial investment of $5,300,000. It would generate $946,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,108,000.

Project 2: Purchase Patent for New Product

The patent would cost $3,715,000, which would be fully amortized over five years. Production of this product would generate $631,550 additional annual net income for Hearne.

Project 3: Purchase a New Fleet of Delivery Trucks

Hearne could purchase 25 new delivery trucks at a cost of $160,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,900. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $680,000 of additional net income per year.

1. Determine each project's accounting rate of return. (Round your answers to 2 decimal places.)



2. Determine each project's payback period. (Round your answers to 2 decimal places.)



3. Using a discount rate of 10 percent, calculate the net present value of each project. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Round your intermediate calculations to 4 decimal places and final answers to 2 decimal places.)



4. Determine the profitability index of each project and prioritize the projects for Hearne. (Round your intermediate calculations to 2 decimal places. Round your final answers to 4 decimal places.)

Solutions

Expert Solution

1) Annual Rate of Return & Payback Period are calculated in the table below:

Project 1	Retooling Manufacturing Facility
	Particulars	Amount
(A)	Initial Investment	5,300,000
(B)	Net Cash Flow p.a.	946,000
	Accounting Rate of Return (B) / (A)	18%
	Salvage Value	1,108,000
	Net Investment (A) - Salvage Value	4,192,000
	Payback Period (Years)	4.43

Project 2	Purchase Patent for New Product
	Particulars	Amount
(A)	Cost of Patent	3,715,000
(B)	Annual Net Income	631,550
	Accounting Rate of Return (B) / (A)	17%
	Salvage Value	-
	Net Investment (A) - Salvage Value	3,715,000
	Payback Period (Years)	5.88


Project 3	Purchase a New Fleet of Delivery Trucks
	Particulars	Amount
(A)	Cost of Trucks ( 25 @ 160,000 each)	4,000,000
(B)	Annual Net Income	680,000
	Accounting Rate of Return (B) / (A)	17%
	Salvage Value	147,500
	Net Investment (A) - Salvage Value	3,852,500
	Payback Period (Years)	5.67

2) Present Value of Cash Flow for each project is as below:

Project 1	Retooling Manufacturing Facility
Cash Flow	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Total
Initial Investment	(5,300,000)
Annual Cash Inflow	-	946,000	946,000	946,000	946,000	946,000	946,000	946,000	946,000
PV Factor	1	0.9091	0.8264	0.7513	0.6830	0.6209	0.5645	0.5132	0.4665
Present Value of Cash Flow	(5,300,000)	860,000	781,818	710,744	646,131	587,392	533,992	485,448	441,316	(253,160)

Project 2	Purchase Patent for New Product
Cash Flow	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Initial Investment	(3,715,000)
Annual Cash Inflow	-	631,550	631,550	631,550	631,550	631,550
PV Factor	1	0.9091	0.8264	0.7513	0.6830	0.6209
Present Value of Cash Flow	(3,715,000)	574,136	521,942	474,493	431,357	392,143	(1,320,929)

Project 3	Purchase a New Fleet of Delivery Trucks
Cash Flow	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10	Total
Initial Investment	(4,000,000)
Annual Cash Inflow	-	680,000	680,000	680,000	680,000	680,000	680,000	680,000	680,000	680,000	680,000
PV Factor	1	0.9091	0.8264	0.7513	0.6830	0.6209	0.5645	0.5132	0.4665	0.4241	0.3855
Present Value of Cash Flow	(4,000,000)	618,182	561,983	510,894	464,449	422,226	383,842	348,948	317,225	288,386	262,169	178,306

3) Profitability Index & Priority of Project are as follows:

ekkarill92 answered 1 year ago

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