Question

1. Please consider the following data. The data will be used for the entire problem. Only move forward the viable investments to the next capital rationing model. Meaning if the investment passes the capital rationing test, put that investment into the next model. i.e. if one of the investments doesn’t pass the payback test, don’t move it forward to ROR.

Bonnet Corporation is considering 8 different investments. Here is the data for the 8 investments:

	McCoy	Stede	Rackham	Lavasseur	Anthos
Investment	$525,000	$600,000	$820,000	$337,500	$1,350,000.00
Salvage Value	$72,000	$83,000	$104,000	$65,000	$550,000
Net cash flows:
Year 1	$125,000	$155,000	$390,000	$180,000	$220,000
Year 2	$105,000	$155,000	$245,000	$122,000	$194,000
Year 3	$85,000	$155,000	$128,000	$84,000	$179,000
Year 4	$105,000	$155,000	$62,000		$205,000
Year 5	$125,000		$43,000		$247,000
Year 6					$272,000
Discount Rate	16.75%	5.95%	14.15%	9.25%	16.50%

	Drake	Sansho	Trepidation
Investment	$310,000.00	$195,000.00	$1,095,000.00
Salvage Value	$3,500	$30,000	$275,000
Net cash flows:
Year 1	$105,000	$77,500	$145,000
Year 2	$105,000	$77,500	$252,000
Year 3	$105,000	$77,500	$306,000
Year 4	$105,000		$289,000
Year 5			$257,000
Year 6
Discount Rate	4.95%	10.55%	9.50%

1. Describe the payback period. Include strengths and weaknesses. (4 points)
2. Calculate the payback period of each investment. (round to nearest tenth) (20 points)
3. Which investments are acceptable? Which investment is the best? Why? (4 points)
4. Describe the AROR. Include strengths and weaknesses. (4 points)
5. Calculate the AROR for each investment. (round to nearest hundredth) (20 points)
6. Consider the discount rate as the minimum rate of return for Bonnet Corp. Which investment is superior? Why? (4 points)
7. What is the NPV? What are its Strengths and weaknesses? (4 points)
8. Calculate the NPV for each remaining investment. (20 points)
9. Calculate the profitability index of each. (6 points each)
10. Which investment is superior? Why? (4 points)
11. After you make your selection for the investment. 6 month’s time passes and an evaluation is taken. The evaluation discover the investment is underperforming. Your board wants you to spend more money to make this investment work. What will your response be? Why?

Answer 1

Sol .I have only answered four sub parts.If you require others to be answered then, kindly re-post the main question with the unanswered sub parts.  

a) Payback period:

It is the capital budgeting that helps in determining the length of time required to recover the cost of an investment.It is the period of time in which an investment reaches its break even point.

Break even point is the situation of no profit and no loss which means the cost of an investment.

Strengths of Payback Period:

• It is helpfui in assessing the investment risk.
• It is the best way to compare the projects and take the best project that has shorter payback period.
• It is helpful in reducing the risk of losses.
• Easy to calculate and understand.

Weakness of Payback Period:

• It does not consider the time value of money.
• It neglects the project's retun on investment.
• It ignores profitability.

b) McCoy investment

Year	Cash Flow	Current Cash Flow
0	$525,000	-
1	$125,000	$125,000
2	$105,000	$230,000
3	$85,000	$315,000
4	$105,000	$420,000
5	$125,000	$545,000

The difference between current cash flow of 5th year of $545,000 and 4th year of $420,000 is $125,000 which is the cash flow of 5th year.

The 5th year has more amount than the investment amount.

The 4th year has lower amount than the investment amount.

The difference of 4th year amount of $420,000 and investment of $525,000 is $105,000.

Divide the $105,000 by the $125,000 to calculate the additional amount of time.

Determine the payback period of McCoy investment by adding the 4 years to the additional amount of time of 0.8.

Stede

Years	Net Cash Flow	Current Cash Flow
0	600,000	-
1	$155,000	$155,000
2	$155,000	$310,000
3	$155,000	$465,000
4	$155,000	$620,000

The difference between current cash flow of 4th year of $620,000 and 3rd year of $465,000 is $155,000 which is the cash flow of 4th year.

The 4th year has more amount than the investment amount.

The 3rd year has lower amount than the investment amount.

The difference of 3rd year amount of $465,000 and investment of $600,000 is $135,000.

Divide the $135,000 by the $155,000 to calculate the additional amount of time.

Determine the payback period of Stede investment by adding the 3 years to the additional amount of time of 0.9.

Rickham

Years	Net Cash Flow	Current Cash Flow
0	$820,000	-
1	$390,000	$390,000
2	$245,000	$635,000
3	$128,000	$763,000
4	$62,000	$825,000
5	$43,000	$868,000

The difference between current cash flow of 4th year of $825,000 and 3rd year of $763,000 is $62,000 which is the cash flow of 4th year.

The 4th year has more amount than the investment amount.

The 3rd year has lower amount than the investment amount.

The difference of 3rd year amount of $763,000 and investment of $820,000 is $57,000.

Divide the $57,000 by the $62,000 to calculate the additional amount of time.

Determine the payback period of Rickham investment by adding the 3 years to the additional amount of time of 0.9.

Lavasseur

Years	Net Cash Flow	Current Cash Flow
0	$337,500	-
1	$180,000	$180,000
2	$122,000	$302,000
3	$84,000	$386,000

The difference between current cash flow of 3rd year of $386,000 and 2nd year of $302,000 is $84,000 which is the cash flow of 3rd year.

The 3rd year has more amount than the investment amount.

The 2nd year has lower amount than the investment amount.

The difference of 2nd year amount of $302,000 and investment of $337,500 is $35,500.

Divide the $35,500 by the $84,000 to calculate the additional amount of time.

Determine the payback period of Lavasseur investment by adding the 2 years to the additional amount of time of 0.4.

Anthos

Years	Net Cash Flow	Current Cash Flow
0	$1,350,000	-
1	$220,000	$220,000
2	$194,000	$414,000
3	$179,000	$593,000
4	$205,000	$798,000
5	$247,000	$1,045,000
6	$272,000	$1,317,000

It does not have any payback period as it does not reach to the initial investment amount.

It does not pass the payback.

Drake

Years	Net Cash Flow	Current Cash Flow
0	$310,000.00	-
1	$105,000	$105,000
2	$105,000	$210,000
3	$105,000	$315,000
4	$105,000	$420,000

The difference between current cash flow of 3rd year of $315,000 and 2nd year of $210,000 is $105,000 which is the cash flow of 3rd year.

The 3rd year has more amount than the investment amount.

The 2nd year has lower amount than the investment amount.

The difference of 2nd year amount of $210,000 and investment of $310,000 is $100,000.

Divide the $100,000 by the $105,000 to calculate the additional amount of time.

Determine the payback period of Drake investment by adding the 2 years to the additional amount of time of 0.9.

Sansho

Years	Net Cash Flow	Current Cash Flow
0	$195,000.00	-
1	$77,500	$77,500
2	$77,500	$155,000
3	$77,500	$232,500

The difference between current cash flow of 3rd year of $232,500 and 2nd year of $155,000 is $77,500 which is the cash flow of 3rd year.

The 3rd year has more amount than the investment amount.

The 2nd year has lower amount than the investment amount.

The difference of 2nd year amount of $155,000 and investment of $195,000 is $40,000.

Divide the $40,000 by the $77,500 to calculate the additional amount of time.

Determine the payback period of Sansho investment by adding the 2 years to the additional amount of time of 0.5.

Trepidation

Years	Net Cash Flow	Current Cash Flow
0	$1,095,000.00	-
1	$145,000	$145,000
2	$252,000	$397,000
3	$306,000	$703,000
4	$289,000	$992,000
5	$257,000	$1,249,000

The difference between current cash flow of 5th year of $1,249,000 and 4th year of $992,000 is $257,000 which is the cash flow of 5th year.

The 5th year has more amount than the investment amount.

The 4th year has lower amount than the investment amount.

The difference of 4th year amount of $992,000 and investment of $1,095,000 is $103,000.

Divide the $100,000 by the $105,000 to calculate the additional amount of time.

Determine the payback period of Trepidation investment by adding the 2 years to the additional amount of time of 0.4.

c) Each investment is acceptable except Anthos investment because it does not have the payback period which will create the loss for the company.The best investments are trepidation and Lavasseur as they both has lower pay back period which is 2.4 yrs than other investments.

d) AROR (Accounting Rate of Return) is the capital budgeting technique which help in determining the return from the net income of proposed investment.It is also known as the Average Rate of Return.

AROR is calculated by dividing the net profit by the amount of investment.

Strengths of AROR:

• It only takes the value of net profit of the projects.
• Easy to understand and calculate.
• It is the most reliable method.

Weakness of AROR:

• It does not consider the time value of money.
• It does not take value of cash inflow and cash outflow.
• The return does not remain constant over useful life of a project.