Question

Average Rate of Return Method, Net Present Value Method, and Analysis for a service company

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	$63,000		$207,000			$132,000		$331,000
2	63,000		207,000			101,000		279,000
3	63,000		207,000			50,000		197,000
4	63,000		207,000			22,000		135,000
5	63,000		207,000			10,000		93,000
Total	$315,000		$1,035,000			$315,000		$1,035,000

Each project requires an investment of $600,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 12% 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.

Please answer problem by filling in the blanks. Thanks

Answer 1

1a
Initial Investment	600,000
Average rate of return	Average Return/Average Investment
Average rate of return	10.50%
	Average rate of return
Front End	10.50%
Green House	10.50%

1b	Front End	Green House
Present Value of Net Cashflow	746,235	796,801
Amount to be invested	600,000	600,000
Net Present Value	146,235	196,801

Working:

	Front End		Green House			Present Value
Year	Income	Cashflow	Income	Cashflow	Discounting Factor	Front End	Green House
1	63,000	207,000	132,000	331,000	0.893	184,851	295,583
2	63,000	207,000	101,000	279,000	0.797	164,979	222,363
3	63,000	207,000	50,000	197,000	0.712	147,384	140,264
4	63,000	207,000	22,000	135,000	0.636	131,652	85,860
5	63,000	207,000	10,000	93,000	0.567	117,369	52,731
Total	315,000		315,000			746,235	796,801
Average Cash Flow	63,000		63,000

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

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