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.

    

Project 1: Retooling Manufacturing Facility

This project would require an initial investment of $4,850,000. It would generate $865,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,000,000.

Project 2: Purchase Patent for New Product

The patent would cost $3,400,000, which would be fully amortized over five years. Production of this product would generate $425,000 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 $115,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,000. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $200,000 of additional net income per year.

     

Required:
1.	Determine each project's accounting rate of return. (Round your answers to 2 decimal places.)
Accounting Rate of Return Project 1 % Project 2 % Project 3 % 2. Determine each project's payback period. (Round your answers to 2 decimal places.) Payback Period Project 1 Years Project 2 Years Project 3 Years     3. Using a discount rate of 10 percent, calculate the net present value of each project. (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. Round your final answers to 2 decimal places.) Net Present Value Project 1 Project 2 Project 3     4. Determine the profitability index of each project and prioritize the projects for Hearne. (Round your intermediate calculations to 2 decimal places. Round your final answers to 4 decimal places.) PI Rank Project 1 Project 2 Project 3 rank 1,2, 3

Answer 1

Accounting Rate of Return
Project 1	13.12%
Project 2	25.00%
Project 3	13.33%

Payback Period
Project 1	5.61
Project 2	3.08
Project 3	6.05

Net present Value
Project 1	231,215.80
Project 2	788,811.90
Project 3	91,858.50

Profitability Index		Rank
Project 1	1.05	2
Project 2	1.23	3
Project 3	1.03	1

		Project 1				Project 2				Project 3
		Outflow	Inflow	PV Factor	Present Value	Outflow	Inflow	PV Factor	Present Value	Outflow	Inflow	PV Factor	Present Value
a	Initial investment	4,850,000.00				3,400,000.00				2,875,000.00
b	Cash Flow		865,000.00	5.33492	4,614,705.80		1,105,000.00	3.790780	4,188,811.90		475,000.00	6.14456	2,918,666.00
c	Salavge Value		1,000,000.00	0.46651	466,510.00		-				125,000.00	0.38554	48,192.50
d	Present Value of Cash Flows	4,850,000.00			5,081,215.80	3,400,000.00			4,188,811.90	2,875,000.00			2,966,858.50
e	Depreciation/Amortization		481,250.00				680,000.00				275,000.00
f	Net Income		383,750.00				425,000.00				200,000.00
g	Average Investment	2,925,000.00				1,700,000.00				1,500,000.00
h	Accounting Rate of Return(f/g)	13.12%				25.00%				13.33%
i	Payback Period(a/b)	5.61				3.08				6.05
j	Net present Value(d-a)	231,215.80				788,811.90				91,858.50
k	Profitability Index(d/a)	1.05				1.23				1.03

Year	Present Value factor	Annuity
1	0.90909
2	0.82645
3	0.75131
4	0.68301
5	0.62092	3.79078
6	0.56447
7	0.51316
8	0.46651	5.33492
9	0.4241
10	0.38554	6.14456

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