Question

Hearne Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them. Assume straight line depreciation method is used. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided.)

Project 1: Retooling Manufacturing Facility
This project would require an initial investment of $4,920,000. It would generate $928,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,870,000.

Project 2: Purchase Patent for New Product
The patent would cost $3,645,000, which would be fully amortized over five years. Production of this product would generate $583,200 additional annual net income for Hearne.

Project 3: Purchase a New Fleet of Delivery Trucks
Hearne could purchase 25 new delivery trucks at a cost of $141,600 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,700. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $234,000 of additional net income per year.

Required:
1. Determine each project's accounting rate of return.
2. Determine each project's payback period.
3. Using a discount rate of 10 percent, calculate the net present value of each project.
4. Determine the profitability index of each project and prioritize the projects for Hearne.

I'm not understanding the Accounting Rate of Return for three projects.

And on Project 1 and 3 on Net Present Value my answers were incorrect.

Also on Project 1 on Profitability Index my answer was incorrect.

If you can please help me. Thank you.

Answer 1

1. Accounting Rate of Return = Accounting Profit / Initial Investment *100

Particulars	Net Cash Flow	Depreciation	Accounting Profit	Initial Investment	Accounting Rate of Return	Rank
Retooling Manufacturing Facility	928,000.00	381,250.00	546,750.00	4,920,000.00	11%	2nd
Patent for New Product	583,200.00	-	583,200.00	3,645,000.00	16%	Ist
New Fleet of Trucks	234,000.00	339,750.00	-105,750.00	3,540,000.00	-3%	3rd

2. Payback Period

Payback Period = Initial Investment / Annual Cashflows

Particulars	Net Cash Flow	Initial Investment	Payback Period (Years)	Rank
Retooling Manufacturing Facility	928,000.00	4,920,000.00	5.30	Ist
Patent for New Product	583,200.00	3,645,000.00	6.25	2nd
New Fleet of Trucks	234,000.00	3,540,000.00	15.13	3rd

3. Net Present Value

Particulars	Net Present Value ($)	Rank
Retooling Manufacturing Facility	905,140.00	Ist
Patent for New Product	-1,434,672.00	2nd
New Fleet of Trucks	-2,047,665.00	3rd

Workings

Retooling Manufacturing Facility
Particulars	Amount ($)	Year	PVF @ 10%	Present Value ($)
Initial investment	-4,920,000.00	0	1.00	-4,920,000.00
Net Cash Flows	928,000.00	1-8	5.33	4,946,240.00
Salvage Value	1,870,000.00	8	0.47	878,900.00
NPV	905,140.00

Patent for New Product
Particulars	Amount ($)	Year	PVF @ 10%	Present Value ($)
Initial investment	-3,645,000.00	0	1.00	-3,645,000.00
Net Cash Flows	583,200.00	1-5	3.79	2,210,328.00
NPV	-1,434,672.00

New Fleet of Trucks
Particulars	Amount ($)	Year	PVF @ 10%	Present Value ($)
Initial investment	-3,540,000.00	0	1.00	-3,540,000.00
Net Cash Flows	234,000.00	1-10	6.14	1,436,760.00
Salvage Value	142,500.00	10	0.39	55,575.00
NPV	-2,047,665.00

4. Profitability Index = Present Value of Future Cashflows / Initial Investment

Particulars	Present Value of Net Cash Flow	Initial Investment	Profitability Index	Rank
Retooling Manufacturing Facility	5,825,140.00	4,920,000.00	1.18	Ist
Patent for New Product	2,210,328.00	3,645,000.00	0.61	3rd
New Fleet of Trucks	1,492,335.00	3,540,000.00	0.42	2nd