Question

HomeGrown Company is a chain of grocery stores that are similar to indoor farmer's markets, providing fresh, local produce, meats, and dairy products to consumers in urban areas. HomeGrown is considering opening several stores in a new city, and has proposals from three contractors (Alpha, Beta, and Gamma companies) who would like to provide buildings for the new stores. The amount of expected revenue from the stores will depend on the design of the contractor. For example, if HomeGrown decides on a more open floor plan, with less shelf space for products, revenue would be lower overall. However, if HomeGrown decides on a very crowded floor plan, it may lose customers who appreciate a more open feel. As the project manager for HomeGrown, you are responsible for deciding which if any of the proposals to accept. HomeGrown's minimum acceptable rate of return is 20%. You receive the following data from the three contractors: Proposal Type of Floor Plan Investment if Selected Residual Value Alpha Very open, like an indoor farmer’s market $1,472,000 $0.00 Beta Standard grocery shelving and layout, minimal aisle space $5,678,900 $0.00 Gamma Mix of open areas and shelving areas $2,325,760 $0.00 You have computed estimates of annual cash flows and average annual income from customers for each of the three contractors' plans. You believe that the annual cash flows will be equal for each of the 10 years for which you are preparing your capital investment analysis. Your conclusions are presented in the following table. Proposal Estimated Average Annual Income Estimated Average (after depreciation) Annual Cash Flow Alpha $302,054 $351,145 Beta $272,019 $489,805 Gamma $571,090 $654,469 You begin by trying to eliminate any proposals that are not yielding the company’s minimum required rate of return of 20%. Complete the following table, and decide whether Alpha, Beta, and/or Gamma should be eliminated because the average rate of return of their project is less than the company's minimum required rate of return. Complete the following table. Enter the average rates of return as percentages rounded to two decimal places. Proposal Average Investment Average Rate of Return Accept or Reject? Estimated Average Annual Income Alpha $ $ % Beta $ $ % Gamma $ $ % You’ve decided to confirm your results from the average rate of return by using the cash payback method. Using the following table, compute the cash payback period of each investment. If required, round the number of years in the cash payback period to a whole number. Proposal Initial Cost Annual Net Cash Inflow Cash Payback Period in Years Alpha $ $ Beta $ $ Gamma $ $ Even though you’re fairly certain that your evaluation and elimination is correct, you would like to compare the three proposals using the net present value method, and get some data about the internal rate of return of the proposals, each of which are expected to generate their respective annual net cash inflows for a period of 10 years. Compute the net present value of each proposal. You may need the following partial table of factors for present value of an annuity of $1. Enter amounts that represent cash outflows as negative numbers using a minus sign. Round the present value of annual net cash flows to the nearest dollar. Present Value of an Annuity of $1 at Compound Interest (Partial Table) Year 10% 20% 1 0.909 0.833 5 3.791 2.991 10 6.145 4.192 Alpha Beta Gamma Annual net cash flow $ $ $ Present value factor Present value of annual net cash flows $ $ $ Less amount to be invested $ $ $ Net present value $ $ $

Answer 1

Average Rate of Return:

Average Rate of Return = Average annual net earnings after tax divided by Initial Investment multiplied by 100

In this case, it is initial one-time investment and hence above formulae can be used.

If the investment is planned over period of time, average value of investment has to be arrived and average earnings has to be divided by average investment and then multiply the result by 100 to get %

Proposal	Estimated Average Annual Income	Average Investment	Average rate of return	Minimum Required rate of return is 20%; if COLUMN C is equal to or more than 20%, ACCEPT or REJECT
	A ***	B	C=A/B
Alpha	302,054	1,472,000	20.52%	Accept
Beta	272,019	5,678,900	4.79%	Reject
Gamma	571,090	2,325,760	24.55%	Accept

*** Since Annual income of every year remains same, instead of computing the average separately, we have taken the income given as it is as average income; if it is not same year on year, then average income has to be computed by sum up of each year income and divide the result by number of years.

Based on above table, Proposal Beta can be rejected.

Cash Pay back method:

In case of Even cash flows year on year, Cash pay back period = Initial investment divided by average annual cash flow.

Proposal	Initial Investment	Annual Net Cash inflow	Cash pay back period (Number of years) (rounded off to 0 decimal places)
	A	B	C=A/B
Alpha	1,472,000	351,145	4
Beta	5,678,900	489,805	12
Gamma	2,325,760	654,469	4

Computation of net present value of each proposal.

		Alpha	Beta	Gamma
Annual Net Cash inflow (as given)	A	351,145	489,805	654,469
Present Value Factor for 10 years @ 20% (as given)	B	4.192
Present value of annual net cash flows	C = A*B	1,472,000	2,053,263	2,743,534
Amount to be invested (as given)	D	1,472,000	5,678,900	2,325,760
Net Present Value	C-D	0	-3,625,637	417,774

Thus, even as per NPV method, Proposal Beta has to be rejected as it is not generating the inflow within expected life of 10 years.

Kindly give me a ?.It helps me. Thanks!!