Question

V. S. Yogurt is considering two possible expansion plans. Proposal A involves opening 10 stores in northern California at a total cost of $3,150,000. Under another strategy, Proposal B, V. S. Yogurt would focus on southern California and open six stores for a total cost of $2,500,000. Selected data regarding the two proposals have been assembled by the controller of V. S. Yogurt as follows.

	Proposal A		Proposal B
Required investment	$	3,150,000	$	2,500,000
Estimated life of store locations		7 years		7 years
Estimated salvage value	$	0	$	400,000
Estimated annual net cash flow		750,000		570,000
Depreciation on equipment (straight-line basis)		450,000		300,000
Estimated annual net income		?		?

  

Required:
a. For each proposal, compute the following. Assume discounted at management's required rate of return of 15 percent. Use Exhibits 26-3 and 26-4 where necessary.

(1) Payback period
(2) Return on average investment
(3) Net present value
b. On the basis of your analysis in part a, state which proposal you would recommend.

Answer 1

		Proposal A	Proposal B
	Investment	$3,150,000	$2,500,000
	annual income	300000	270000
(1)	Payback period	10.50	9.26
		(3,150,000/300,000)	(2,500,000/270,000)
(2)	Return on average investment				1	0.86957
		Proposal A	Proposal B			2	0.75614
	Annual income	300000	270000			3	0.65752
	Investment	$3,150,000	$2,500,000			4	0.57175
	Return	9.52%	10.80%			5	0.49718
		(300,000/3,150,000)	(270,000/2,500,000)			6	0.43233
						7	0.37594
(3)		Proposal A	Proposal B				4.16043
	Annual cash inflow	750000	570000
	Present value annuity factor @ 15%	4.16043	4.16043
	Present value	3120322.5	2371445.1
	Present value of salvage value		150376
		3,120,323	2,521,821
	Initial investement	$3,150,000	$2,500,000
	NPV	(29,677)	21,821
	NPV of the Proposal B is positive same should be accepted.