Question

omeGrown 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	Investment 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	2,525,960	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 capital investment analysis. Your conclusions are presented in the following table.

Proposal	Estimated Average
	Annual Income	Estimated Average
	(after depreciation)	Annual Cash Flow
Alpha	$313,094	$351,145
Beta	272,019	461,411
Gamma	620,249	717,120

Method comparison

Please make a check box for the 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 average rate of return, cash payback period, net present value, and internal rate of return methods.

	Average Rate of Return Method	Cash Payback Method	Net Present Value Method	Internal Rate of Return Method
Considers the time value of money
Does not consider the time value of money
Easy to compute
Not as easy to compute
Directly considers expected cash flows
Directly considers timing of expected cash flows
Assumes cash flows can be reinvested at minimum desired rate of return
Can be used to rank proposals even if project lives are not the same

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		Average Investment	Average Rate of Return	Accept or Reject?
	Estimated Average
	Annual Income
Alpha
Beta
Gamma

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 value present

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 present value of an annuity of $1. Enter amounts that represent cash outflows as negative numbers using a minus sign. Round the present value of annual net cash flows to the nearest dollar.

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	A.=20%, B. <20%, C. >20%
Beta	A.=20%, B. <20%, C. >20%
Gamma	A.=20%, B. <20%, C. >20%

2. What can you say about these proposals? Check all that apply.

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

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

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

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

Alpha

Beta

Gamma

Answer 1

1. Average Rate of Return
	A	B	A/B*100
	Annual Income	Average investment	Average Rate of Return	Accept or reject
Alpha	313094	1472000	21.27%	Accept
Beta	272019	5678900	4.79%	Reject
Gama	620249	2525960	24.55%	Accept
2. Cash Payback Method
	A	B	A/B*100
	Intial Cost	Annual Net Cash Flow	Cash payback period Years
Alpha	1472000	351145	4.19	Year
Beta	5678900	461411	12.31	Year
Gama	2525960	717120	3.52	Year
3. Net Present Value
		Alpha	Beta	Gama
	Annual Net Cash Flow	351145	461411	717120
	Present Value Factor 20%	4.192	4.192	4.192
	Present Value of annual net cash flow	1472000	1934235	3006167
	Amount to be invested	-1472000	-5678900	-2525960
	Net Present Value	0	-3744665	480207
	Internal Rate of return	20%	More than 20%	Less Then 20%
		at IRR, NPV is zero	IRR increased means disount value will be lower and hence negative NPV	IRR decreased means disount value will be higher and hence positive NPV
	Gama is the best since it has
	Higher Average Rate of Return
	Lower Pay Back period
	and Higher NPV