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Question: Hearne Company has a number of potential capital investments. Because these projects vary in natu...

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 $5,250,000. It would generate $937,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,096,000.

Project 2: Purchase Patent for New Product

The patent would cost $3,680,000, which would be fully amortized over five years. Production of this product would generate $607,200 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 $155,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,800. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $639,400 of additional net income per year.


Required:
1. Determine each project's accounting rate of return. (Round your answers to 2 decimal places.)
Project1%-

Project2%-

Project3%-
       

2. Determine each project's payback period. (Round your answers to 2 decimal places.)
Project1Years-

Project2Years

Project3Years
       

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 intermediate calculations to 4 decimal places and final answers to 2 decimal places.)

Not present value:

Project1:

Project2:

Project3:

       

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.)
Profability iNdex:

Project1:

Porject2:

Project3:

Answer 1

Basic Data Calculations

Project 1

Cash Flow = $937000

Depreciation = ($5250000 - 1096000) / 8 = 519250

Net Income = $937000 - 519250 = 417,750

Investment = $5250000

Project 2

Net Income = $607200

Depreciation = $3680000 / 5 = 736000

Cash Flow = 607200 + 736000 = 1343200

Investment = 3680000

Project 3

Net Income = $639400

Depreciation = [ (25 x 155000 ) – (25 x 5800) ] /10 = $373000

Cash Flow = 639400 + 373000 = 1012400

Investment = 3875000

1.Accounting Rate of Return

	Accounting Rate of Return
Project 1	8%
Project 2	17%
Project 3	17%

Accounting Rate of Return = ( Net Income / investment ) * 100

Project 1

= (417750 / 5250000) x 100

= 8%

Project 2

= (607200 / 3680000) x 100

= 17%

Project 3

= (639400 / 3875000) x 100

= 17%

2.Payback Period

	Payback Period
Project 1	5.60 Years
Project 2	2.74 Years
Project 3	3.83 Years

Pay Back Period = Investment / Cash Flow

Project 1

= 5250000 / 937000

= 5.60 Years

Project 2

= 3680000 / 1343200

= 2.74 Years

Project 3

= 3875000 / 1012400

= 3.83 Years

3.Net Present Value at 10%

	Net Present Value
Project 1	$ 260,085.30
Project 2	$ 1,411,802.56
Project 3	$ 2,401,589.30

NPV = Present Value of Inflow – Investment

Project 1

= (937000 x 5.3349) + (1096000 x 0.4665) – 5250000

= $ 260,085.30

Project 2

= (1343200 x 3.7908) - 3680000

= $ 1,411,802.56

Project 3

= (1,012,400 x 6.1445) + (145000 x 0.3855) – 3875000

= $ 2,401,589.30

4.Profitablity Index

	Profitability Index
Project 1	1.05
Project 2	1.38
Project 3	1.62

Profitablity Index = Present Value of Inflow / Investment

Project 1

= [ (937000 x 5.3349) + (1096000 x 0.4665) ] / 5250000

= 1.05

Project 2

= [ (1343200 x 3.7908) [ / 3680000

= 1.38

Project 3

= [ (1,012,400 x 6.1445) + (145000 x 0.3855) ] / 3875000

= 1.62