Question

The capital investment committee of Arches Landscaping Company is considering two capital investments. The estimated income from operations and net cash flows from each investment are as follows:

	Front-End Loader					Greenhouse
Year	Income from Operations		Net Cash Flow			Income from Operations		Net Cash Flow
1	$35,700		$116,000			$75,000		$186,000
2	35,700		116,000			57,000		157,000
3	35,700		116,000			29,000		110,000
4	35,700		116,000			12,000		75,000
5	35,700		116,000			5,500		52,000
Total	$178,500		$580,000			$178,500		$580,000

Each project requires an investment of $420,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 10% 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
Front-End Loader	%
Greenhouse	%

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.

	Front-End Loader	Greenhouse
Present value of net cash flow	$	$
Amount to be invested	$	$
Net present value	$	$

2. Prepare a brief report for the capital investment committee, advising it on the relative merits of the two investments.

The front-end loader has a net present value because cash flows occur in time compared to the greenhouse. Thus, if only one of the two projects can be accepted, the would be the more attractive.

Answer 1

Requirement-1(a)

Front-End Loader

Average rate of return       = Average annual net profit / Average Investment

= 35,700 / 210,000

= 0.17 x 100 = 17%

Average annual net profit = total net profit / useful life

= 178,500/ 5

= 35,700

Average investment = Initial Investment + salvage value / 2

= 420,000 + 0 / 2

= 210,000

Greenhouse

Average rate of return       = Average annual net profit / Average Investment

= 35,700 / 210,000

= 0.17 x 100 = 17%

Average annual net profit = total net profit / useful life

= 178,500/ 5

= 35,700

Average investment = Initial Investment + salvage value / 2

= 420,000 + 0 / 2

= 210,000

	Average rate of return
Front-End Loader	17%
Greenhouse	17%

Requirement-1(b)
Front-End Loader
Year	cash flow	Discount factor (10%)	discounted cash flow
1	116,000	0.909	105444
2	116,000	0.826	95816
3	116,000	0.751	87116
4	116,000	0.683	79228
5	116,000	0.621	72036
Total net present value			439640

Front-End Loader

NPV = present value - initial investment

= 439,640 - 420,000

= 19,640

Greenhouse
Year	cash flow	Discount factor (10%)	discounted cash flow
1	186,000	0.909	169074
2	157,000	0.826	129682
3	110,000	0.751	82610
4	75,000	0.683	51225
5	52,000	0.621	32292
Total net present value			464883

Greenhouse

NPV = present value - initial investment

= 464,833 - 420,000

= 44,833

	Front-End Loader	Greenhouse
present value of net cash flow	439,640	464,833
Amount to be invested	420,000	420,000
net present value	19,640	44,833

Requirement-2

Average rate of return of both the projects are equal but Net present value of Greenhouse is higher than Front-End Loader so, the company should accept the project of Greenhouse.