Question

PA11-3 Comparing, Prioritizing Multiple Projects [LO 11-1, 11-2, 11-3, 11-6]

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 $5,500,000. It would generate $982,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,156,000.

Project 2: Purchase Patent for New Product

The patent would cost $3,855,000, which would be fully amortized over five years. Production of this product would generate $732,450 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 $180,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $6,300. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $855,000 of additional net income per year.


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

Accountng Rate of Return:

Project 1 percentage =

Project 2 percentage =

Project 3 percentage =

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 intermediate calculations to 4 decimal places and 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.)

Profibility Index

Project 1 =

Project 2 =

Project 3 =

Answer 1

Answer

1.

Accounting Rate of Return (ARR) = Net income / Initial Investment

Project 1

Net Income = Annual Cash flow – Depreciation

= $982,000 – [($5,500,000 – 1,156,000) / 8 Years]

Net Income = $439,000

ARR = $439,000 / $5,500,000

ARR = 7.98%

Project 2

ARR = $732,450 / 3,855,000

ARR = 19%

Project 3

ARR = $855,000 / ($180,000 * 25 Trucks)

ARR = 19%

2.

Payback period = Initial Investment / Annual Cash Inflow

Annual Cash Inflow = Net Income + Depreciation

Project 1

= $5,500,000 / $982,000

= 5.6 Years

Project 2

Annual Cash Inflow = Net Income + Depreciation

= $732,450 + ($3,855,000 / 5 Years)

Annual Cash Inflow = $1,503,450

Payback period

= $3,855,000 / $1,503,450

= 2.6 Years

Project 3

Depreciation = (Cost – Salvage Value) / Useful life

= [(180,000 * 25 Trucks) – (6,300 * 25 trucks)] / 10 Years

= $434,250

Annual Cash Inflow = Net Income + Depreciation

= $855,000 + 434,250

Annual Cash Inflow = $1,289,250

Payback period

= (180,000 * 25 Trucks) / $1,289,250

= 3.5 Years

3.

Project 1
1	2	3	2*3
Year	Discount Rate @ 10%	Annual Cash Flow	Present Value
0	1	(5,500,000)	(5,500,000.00)
1	0.90909	982,000	892,727.27
2	0.82645	982,000	811,570.25
3	0.75131	982,000	737,791.13
4	0.68301	982,000	670,719.21
5	0.62092	982,000	609,744.74
6	0.56447	982,000	554,313.40
7	0.51316	982,000	503,921.27
8	0.46651	2,138,000	997,392.78
NPV			278,180.06

Project 2
1	2	3	2*3
Year	Discount Rate @ 10%	Annual Cash Flow	Present Value
0	1	(3,855,000)	(3,855,000.00)
1	0.90909	1,503,450	1,366,772.73
2	0.82645	1,503,450	1,242,520.66
3	0.75131	1,503,450	1,129,564.24
4	0.68301	1,503,450	1,026,876.58
5	0.62092	1,503,450	933,524.16
NPV			1,844,258.37

Project 3
1	2	3	2*3
Year	Discount Rate @ 10%	Annual Cash Flow	Present Value
0	1	(4,500,000)	(4,500,000.00)
1	0.90909	1,289,250	1,172,045.45
2	0.82645	1,289,250	1,065,495.87
3	0.75131	1,289,250	968,632.61
4	0.68301	1,289,250	880,575.10
5	0.62092	1,289,250	800,522.82
6	0.56447	1,289,250	727,748.01
7	0.51316	1,289,250	661,589.10
8	0.46651	1,289,250	601,444.64
9	0.42410	1,289,250	546,767.85
10	0.38554	1,446,750	557,784.75
NPV			3,482,606.21

4.

Profitability Index = Present Value of Cash Inflow / Initial Investment

Project 1

Project 1
1	2	3	2*3
Year	Discount Rate @ 10%	Annual Cash Flow	Present Value
1	0.90909	982,000	892,727
2	0.82645	982,000	811,570
3	0.75131	982,000	737,791
4	0.68301	982,000	670,719
5	0.62092	982,000	609,745
6	0.56447	982,000	554,313
7	0.51316	982,000	503,921
8	0.46651	2,138,000	997,393
Sum			5,778,180

PI = 5,778,180 / 5,500,000

PI = 1.05

Project 2

Project 2
1	2	3	2*3
Year	Discount Rate @ 10%	Annual Cash Flow	Present Value
1	0.90909	1,503,450	1,366,773
2	0.82645	1,503,450	1,242,521
3	0.75131	1,503,450	1,129,564
4	0.68301	1,503,450	1,026,877
5	0.62092	1,503,450	933,524
Sum			5,699,258

PI = $5,699,258 / 3,855,000

PI = 1.48

Project 3

Project 3
1	2	3	2*3
Year	Discount Rate @ 10%	Annual Cash Flow	Present Value
1	0.90909	1,289,250	1,172,045
2	0.82645	1,289,250	1,065,496
3	0.75131	1,289,250	968,633
4	0.68301	1,289,250	880,575
5	0.62092	1,289,250	800,523
6	0.56447	1,289,250	727,748
7	0.51316	1,289,250	661,589
8	0.46651	1,289,250	601,445
9	0.42410	1,289,250	546,768
10	0.38554	1,446,750	557,785
Sum			7,982,606

PI = $7,982,606 / 4,500,000 (180,000 * 25)

PI = 1.77

Dear Student, if u have any doubt, plz feel free to reach me.