Question

1. HomeGrown Company is a chain of grocery stores that are similar to indoor farmer's markets, providing fresh, local produce, meats, and dairy products to consumers in urban areas. HomeGrown is considering opening several stores in a new city, and has proposals from three contractors (Alpha, Beta, and Gamma companies) who would like to provide buildings for the new stores.

   The amount of expected revenue from the stores will depend on the design of the contractor. For example, if HomeGrown decides on a more open floor plan, with less shelf space for products, revenue would be lower overall. However, if HomeGrown decides on a very crowded floor plan, it may lose customers who appreciate a more open feel.

   As the project manager for HomeGrown, you are responsible for deciding which if any of the proposals to accept. HomeGrown's minimum acceptable rate of return is 20%. You receive the following data from the three contractors:

   Proposal	Type of Floor Plan	Initial Cost if Selected	Residual Value
   Alpha	Very open, like an indoor farmer’s market	$1,472,000	$0.00
   Beta	Standard grocery shelving and layout, minimal aisle space	5,678,900	0.00
   Gamma	Mix of open areas and shelving areas	2,125,560	0.00

   You have computed estimates of annual cash flows and average annual income from customers for each of the three contractors' plans. You believe that the annual cash flows will be equal for each of the 10 years for which you are preparing your The process by which management plans, evaluates, and controls investments in fixed assets.capital investment analysis. Your conclusions are presented in the following table.

   Proposal	Estimated Average Annual Income (after depreciation)	Estimated Average Annual Cash Flow
   Alpha	$313,094	$351,145
   Beta	272,019	475,608
   Gamma	527,245	598,133

   Method Comparison

   Compare methods of capital investment analysis in the following table to begin your evaluation of the three capital investment proposals Alpha, Beta, and Gamma. You decide to compare four methods: the A method of evaluating a capital investment proposal that focuses on the expected profitability of the investment; computed as average annual income divided by average investment. Also referred to as accounting rate of return.average rate of return, A method of evaluating a capital investment proposal that focuses on the expected period of time between the date of an investment and the recovery in cash of the amount invested.cash payback period, A method of analysis of proposed capital investments that focuses on the present value of the cash flows expected from the investments.net present value, and A method of analysis of proposed capital investments that uses present value concepts to compute the rate of return from the net cash flows expected from the investment.internal rate of return methods.

   	Average Rate of Return Method	Cash Payback Method	Net Present Value Method	Internal Rate of Return Method
   Considers the The concept that recognizes that a dollar today is worth more than a dollar tomorrow, because today's dollar can earn interest.time value of money	No Yes No	No Yes No	Yes Yes No	Yes Yes No
   Does not consider the time value of money	Yes Yes No	Yes Yes No	No Yes No	No Yes No
   Easy to compute	Yes Yes No	Yes Yes No	No Yes No	No Yes No
   Not as easy to compute	No Yes No	No Yes No	Yes Yes No	Yes Yes No
   Directly considers expected cash flows	Yes Yes No	Yes Yes No	No Yes No	No Yes No
   Directly considers timing of expected cash flows	No Yes No	No Yes No	Yes Yes No	Yes Yes No
   Assumes cash flows can be reinvested at minimum desired rate of return	No Yes No	No Yes No	Yes Yes No	No Yes No
   Can be used to rank proposals even if project lives are not the same	No Yes No	No Yes No	Yes Yes No	No Yes No

   Average Rate of Return

   You begin by trying to eliminate any proposals that are not yielding the company’s minimum required rate of return of 20%. Complete the following table, and decide whether Alpha, Beta, and/or Gamma should be eliminated because the average rate of return of their project is less than the company's minimum required rate of return.

   Complete the following table. Enter the average rates of return as percentages rounded to two decimal places.

   Proposal	Estimated Average Annual Income	Average Investment	Average Rate of Return	Accept or Reject
   Alpha	$	$	%	Reject Accept Reject
   Beta				Reject Accept Reject
   Gamma				Accept Accept Reject

   Cash Payback Method

   You’ve decided to confirm your results from the average rate of return by using the cash payback method.

   Using the following table, compute the cash payback period of each investment. If required, round the number of years in the cash payback period to a whole number.

   Proposal	Initial Cost	Annual Net Cash Inflow	Cash Payback Period in Years
   Alpha	$	$
   Beta
   Gamma

   Net Present Value

   Even though you’re fairly certain that your evaluation and elimination is correct, you would like to compare the three proposals using the net present value method, and get some data about the internal rate of return of the proposals, each of which are expected to generate their respective annual net cash inflows for a period of 10 years.

   Compute the net present value of each proposal. You may need the following partial table of factors for The amount of cash needed today to yield a series of equal net cash flows at fixed time intervals in the future.present value of an annuity of $1. Round the present value of annual net cash flows to the nearest dollar. If your answer is zero enter "0". For the net present value, if required, use the minus sign (-) to indicate a negative amount.

   Present Value of an Annuity of $1 at Compound Interest (Partial Table)
   Year	10%	20%
   1	0.909	0.833
   5	3.791	2.991
   10	6.145	4.192

   	Alpha	Beta	Gamma
   Annual net cash flow	$	$	$
   Present value factor
   Present value of annual net cash flows	$	$	$
   Amount to be invested
   Net present value	$	$	$

   Final Questions

   After reviewing all your data, answer the following questions (1)-(3).

   1. What can you say about each proposal?

   Proposal	Internal Rate of Return
   Alpha	= 20% = 20% < 20% > 20%
   Beta	< 20% = 20% < 20% > 20%
   Gamma	> 20% = 20% < 20% > 20%

   2. What can you say about these proposals?

   a. HomeGrown would be breaking even (i.e., profit = 0) if Alpha’s proposal is chosen.

   b. Only Gamma’s proposal is yielding more than HomeGrown’s minimum desired rate of return.

   c. Gamma’s proposal is the only proposal that would be acceptable to HomeGrown.

   a and b

   • a
   • b
   • c
   • a and b
   • b and c

   3. Which proposal is the best choice for HomeGrown given the data collected?

Answer 1

	ARR	Cash payback	NPV	IRR
Time value of money	No	No	Yes	Yes
Does not consider Time value	Yes	Yes	No	No
Easy to compute	Yes	Yes	No	No
Not as easy	No	No	Yes	Yes
Directly considers cash flows	No	Yes	Yes	Yes
Directly considers timing of cash flows	No	No	Yes	Yes
Assumes reinvestment at minimum rate of return	No	No	Yes	No
Can be used to rank in case of different project lives	Yes	Yes	No	Yes
	Average Annual Income	Average Investment	Average Rate of return	Accept or Reject
Alpha	313094	736000	42.54%	Accept
Beta	272019	2839450	9.58%	Reject
Gamma	527245	1062780	49.61%	Accept
Cash Payback
	Initial Cost	Average Net cash inflow	Cash Payback period
Alpha	1472000	351145	4
Beta	5678900	475608	12
Gamma	2125560	598133	4
NPV
	Alpha	Beta	Gamma
Annual net cash inflow	351,145	475,608	598,133
PVF	4.192	4.192	4.192
Present value of cash inflows	1,472,000	1,993,749	2,507,374
Amount to be invested	1,472,000	5,678,900	2,125,560
Net Present Value	(0.16)	(3,685,151.26)	381,813.54
	IRR
Alpha	=20%	since NPV = 0
Beta	< 20%	since NPV is negative
Gamma	>20%	since NPV is positive
Only b is correct
As Profit is 20% in Alpha and not 0
Both Alpha and Gamma are acceptable
3.Gamma