Question

Average Rate of Return Method, Net Present Value Method, and Analysis

The capital investment committee of Ellis Transport and Storage Inc. is considering two investment projects. The estimated income from operations and net cash flows from each investment are as follows:

	Warehouse					Tracking Technology
Year	Income from Operations		Net Cash Flow			Income from Operations		Net Cash Flow
1	$55,000		$173,000			$116,000		$277,000
2	55,000		173,000			88,000		234,000
3	55,000		173,000			44,000		164,000
4	55,000		173,000			19,000		112,000
5	55,000		173,000			8,000		78,000
Total	$275,000		$865,000			$275,000		$865,000

Each project requires an investment of $500,000. 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
Warehouse	%
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.

	Warehouse	Tracking Technology
Present value of net cash flow total	$	$
Less amount to be invested	$	$
Net present value	$	$

2. The warehouse has a LARGER / SMALLER net present value as tracking technology cash flows occur EARLIER / MORE EVENLY / LATER in time. Thus, if only one of the two projects can be accepted, the TRACKING TECHNOLOGY / WAREHOUSE would be the more attractive.

Answer 1

Average Annual net income	55000	=275000/5
Average Investment	250000	=500000/2
1a
	Average Rate of Return
Warehouse	22%	=55000/250000
Tracking Technology	22%	=55000/250000
1b
	Warehouse	Tracking Technology
Present value of net cash flow total	623665	666085
Less amount to be invested	500000	500000
Net present value	123665	166085
2
The warehouse has a smaller net present value as tracking technology cash flows occur earlier in time. Thus, if only one of the two projects can be accepted, the Tracking Technology would be the more attractive.
Workings:
	Warehouse			Tracking Technology
Year	Cash flows	PV factor	Present value	Cash flows	PV factor	Present value
1	173000	0.893	154489	277000	0.893	247361
2	173000	0.797	137881	234000	0.797	186498
3	173000	0.712	123176	164000	0.712	116768
4	173000	0.636	110028	112000	0.636	71232
5	173000	0.567	98091	78000	0.567	44226
		Total	623665		Total	666085