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	$25,000		$ 40,000			$11,250		$ 26,250
2	20,000		35,000			11,250		26,250
3	7,000		22,000			11,250		26,250
4	3,000		18,000			11,250		26,250
5	1,250		16,250			11,250		26,250
	$56,250		$131,250			$56,250		$131,250

Each project requires an investment of $75,000. 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
Greenhouse	%
Front-End Loader	%

1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, round to the nearest dollar.

	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 earlier in time compared to the greenhouse. Thus, if only one of the two projects can be accepted, the would be the more attractive.

Answer 1

Front-End Loader			Greenhouse
Year	Income from Operations	Net Cash Flow	Income from Operations	Net Cash Flow
1	$25,000	$40,000	$11,250	$26,250
2	20000	35,000	$11,250	26,250
3	7000	22,000	$11,250	26,250
4	3000	18,000	$11,250	26,250
5	1250	16,250	$11,250	26,250
Total	$56,250	$131,250	$56,250	$131,250
No of years	5		5
Average Rate Total/5	11250		$11,250
Average Rate of Return
Average Profit/Average investment
11250/((75000+0)/2)*100	30	%
Average Rate of Return
Greenhouse	30%
Front-End Loader	30%
	Front-End Loader	Greenhouse
Present value of net cash flow	$99,941	$94,631
Amount to be invested	75000	75000
Net present value	$24,941	$19,631
working
Front-End Loader
Year	Net Cash Flow	Discount factor 12%	Discounted cash flow
1	$40,000	0.893	$35,720
2	35000	0.797	$27,895
3	22000	0.712	$15,664
4	18000	0.636	$11,448
5	16250	0.567	$9,214
	$131,250		$99,941
Greenhouse
Year	Net Cash Flow	Discount factor 12%	Discounted cash flow
1	$26,250	0.893	$23,441
2	$26,250	0.797	$20,921
3	$26,250	0.712	$18,690
4	$26,250	0.636	$16,695
5	$26,250	0.567	$14,884
	$131,250		$94,631
Ans 2
Front end loader has more NPV because cash flow occur earlier. Thus if one of the project
is accepted than Front end loader is better than Freenhouse