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	$34,000		$110,000			$71,000		$176,000
2	34,000		110,000			54,000		149,000
3	34,000		110,000			27,000		105,000
4	34,000		110,000			12,000		72,000
5	34,000		110,000			6,000		48,000
Total	$170,000		$550,000			$170,000		$550,000

Each project requires an investment of $400,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 10% 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	34000	=170000/5
Average Investment	200000	=400000/2
1a
	Average Rate of Return
Warehouse	17%	=34000/200000
Tracking Technology	17%	=34000/200000
1b
	Warehouse	Tracking Technology
Present value of net cash flow total	416900	440897
Less amount to be invested	400000	400000
Net present value	16900	40897
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	Present value	Cash flows	PV factor	Present value
1	110000	0.909	99990	176000	0.909	159984
2	110000	0.826	90860	149000	0.826	123074
3	110000	0.751	82610	105000	0.751	78855
4	110000	0.683	75130	72000	0.683	49176
5	110000	0.621	68310	48000	0.621	29808
		Total	416900		Total	440897