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	$63,800		$205,000			$134,000		$328,000
2	63,800		205,000			102,000		277,000
3	63,800		205,000			51,000		195,000
4	63,800		205,000			22,000		133,000
5	63,800		205,000			10,000		92,000
Total	$319,000		$1,025,000			$319,000		$1,025,000

Each project requires an investment of $580,000. 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.

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   net present value as tracking technology cash flows occur   in time. Thus, if only one of the two projects can be accepted, the   would be the more attractive.

Answer 1

1-a. Average Rate of return = Average Income/Average Investment

	Warehouse	Tracking Technology
Average Income = Total Income/5	63,800	63,800
Average Investment	290,000	290,000
Average Return	22%	22%

1-b NPV = Present value of cash inflows – present value of cash outflows

	Warehouse	Tracking Technology
Present Value of Cash inflow	205000*3.353 = $687,365	744,882
Less: Amount to be invested	580,000	580,000
NPV	107,365	164,882

2. The warehouse project has a LOWER NPV as tracking technology cash flows occur EARLY in time.

Tracking technology would be more attractive