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.

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.)

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.)

Answer 1

Basic Data’s

Project 1

Cash Flow = $865000

Depreciation = ($4850000 – 1000000) / 8 = 481250

Net Income = $865000 – 481250 = 383750

Investment = $4850000

Project 2

Net Income = $425000

Depreciation = $3400000 / 5 =680000

Cash Flow = 425000 + 680000 = 1105000

Investment = 3400000

Project 3

Net Income = $200000

Depreciation = [ (25 x 115000 ) – (25 x 5000) ] /10 = $275000

Cash Flow = 200000 + 275000 = 475000

Investment = 2875000

1.Accounting Rate of Return

= ( Net Income / investment ) * 100

Project 1

= (383750/4850000)*10

= 7.91%

Project 2

= (425000 / 3400000) * 100

= 12.5%

Project 3

= (200000 / 2875000) * 100

= 6.96%

2.Payback Period

= Investment / Cash Flow

Project 1

= 865000 / 4850000

= 5.61 Years

Project 2

= 1105000 / 3400000

= 3.08 Years

Project 3

= 475000 / 2875000

= 6.05 Years

3.Net Present Value at 10%

= Present Value of Inflow – Investment

Project 1

= (865000 x 5.3349) + (1000000 x 0.4665) – 4850000

= $2,31,188.5

Project 2

= (1105000 x 3.7908) - 3400000

= $7,88,834

Project 3

= (475000 x 6.1445) + (125000 x 0.3855) – 2875000

= $91,825

4.Profitablity Index

= Present Value of Inflow / Investment

Project 1

= [ (865000 x 5.3349) + (1000000 x 0.4665) ] / 4850000

= 1.05

Project 2

= (1105000 x 3.7908) / 3400000

= 1.23

Project 3

= [ (475000 x 6.1445) + (125000 x 0.3855) ] 2875000

= 1.03

***IN THIS QUESTION, I HAVE COMPUTED ACCOUNTING RATE OF RETURN , PAYBACK PERIOD, NET PRESENT VALUE AND PROFITABILITY INDEX AS WELL”