In: Accounting
Average Rate of Return Method, Net Present Value Method, and Analysis
The capital investment committee of Overnight Express Inc. is considering two investment projects. The estimated income from operations and net cash flows from each investment are as follows:
Distribution Center Expansion | Internet Tracking Technology | ||||||||||||||||
Year | Income from Operations |
Net Cash Flow |
Income from Operations |
Net Cash Flow |
|||||||||||||
1 | $ 66,000 | $ 226,000 | $200,000 | $ 360,000 | |||||||||||||
2 | 66,000 | 226,000 | 90,000 | 250,000 | |||||||||||||
3 | 66,000 | 226,000 | 30,000 | 190,000 | |||||||||||||
4 | 66,000 | 226,000 | 10,000 | 170,000 | |||||||||||||
5 | 66,000 | 226,000 | 0 | 160,000 | |||||||||||||
Total | $330,000 | $1,130,000 | $330,000 | $1,130,000 |
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 |
Each project requires an investment of $800,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 15% for purposes of the net present value analysis.
Required:
1a. Compute the average rate of return for each investment. Round to one decimal place.
Average Annual Rate of Return | |
Distribution Center Expansion | % |
Internet Tracking Technology | % |
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.
Distribution Center Expansion | Internet Tracking Technology | |||
Present value of net cash flow total | $ | $ | ||
Amount to be invested | ||||
Net present value | $ | $ |
Average annual net income | 66000 | =330000/5 |
Average Investment | 400000 | =800000/2 |
1a | ||
Average Annual Rate of Return | ||
Distribution Center Expansion | 16.5% | =66000/400000 |
Internet Tracking Technology | 16.5% | =66000/400000 |
1b | ||
Distribution Center Expansion | Internet Tracking Technology | |
Present value of net cash flow total | 757778 | 803980 |
Amount to be invested | 800000 | 800000 |
Net present value | -42222 | 3980 |
Workings: | ||||||
Distribution Center Expansion | Internet Tracking Technology | |||||
Cash flows | PV factor 15% | Present value | Cash flows | PV factor 15% | Present value | |
1 | 226000 | 0.870 | 196620 | 360000 | 0.870 | 313200 |
2 | 226000 | 0.756 | 170856 | 250000 | 0.756 | 189000 |
3 | 226000 | 0.658 | 148708 | 190000 | 0.658 | 125020 |
4 | 226000 | 0.572 | 129272 | 170000 | 0.572 | 97240 |
5 | 226000 | 0.497 | 112322 | 160000 | 0.497 | 79520 |
Total | 757778 | Total | 803980 |