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	$63,000		$197,000			$132,000		$315,000
2	63,000		197,000			101,000		266,000
3	63,000		197,000			50,000		187,000
4	63,000		197,000			22,000		128,000
5	63,000		197,000			10,000		89,000
Total	$315,000		$985,000			$315,000		$985,000

Each project requires an investment of $600,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% 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 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.

Answer 1

Average Annual net income	63000
Average Investment	300000	=600000/2
1a
	Average Rate of Return
Warehouse	21%	=63000/300000
Tracking Technology	21%	=63000/300000
1b
	Warehouse	Tracking Technology
Present value of net cash flow total	660541	715641
Less amount to be invested	600000	600000
Net present value	60541	115641
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 15%	Present value	Cash flows	PV factor 15%	Present value
1	197000	0.870	171390	315000	0.870	274050
2	197000	0.756	148932	266000	0.756	201096
3	197000	0.658	129626	187000	0.658	123046
4	197000	0.572	112684	128000	0.572	73216
5	197000	0.497	97909	89000	0.497	44233
		Total	660541		Total	715641