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	$42,000		$138,000			$88,000		$221,000
2	42,000		138,000			67,000		186,000
3	42,000		138,000			34,000		131,000
4	42,000		138,000			15,000		90,000
5	42,000		138,000			6,000		62,000
Total	$210,000		$690,000			$210,000		$690,000

Each project requires an investment of $420,000. 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

Average Annual net income	42000	=210000/5
Average Investment	210000	=420000/2
1a
	Average Rate of Return
Warehouse	20%	=42000/210000
Tracking Technology	20%	=42000/210000
1b
	Warehouse	Tracking Technology
Present value of net cash flow total	464094	503238
Less amount to be invested	420000	420000
Net present value	44094	83238
2
The warehouse has a smaller 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.
Workings:
	Warehouse			Tracking Technology
Year	Cash flows	PV factor 15%	Present value	Cash flows	PV factor 15%	Present value
1	138000	0.870	120060	221000	0.870	192270
2	138000	0.766	105708	186000	0.766	142476
3	138000	0.658	90804	131000	0.658	86198
4	138000	0.572	78936	90000	0.572	51480
5	138000	0.497	68586	62000	0.497	30814
		Total	464094		Total	503238