Question

# HomeGrown Company is a chain of grocery stores that are similar to indoor farmer's markets, providing...

HomeGrown 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

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

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

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

Average rate of return = Average annual income/ Average investment

 Proposal Average annual income Average investment Average rate of return Accept or reject Alfa \$313,094 \$1,472,000 21.27% Accept Beta \$272,019 \$5,678,900 4.79% Reject Gamma \$620,249 \$2,525,960 24.55% Accept

Cash pay back period in years = Initial cost/Annual net cash inflow

 Proposal Initial cost Annual net cash inflow Cash pay back period in years Alpha \$1,472,000 \$351,145 1,472,000/351,145 = 4.19 Beta \$5,678,900 \$461,411 5,678,900/461,411 = 12.31 Gamma \$2,525,960 \$717,120 2,525,960/717,120 = 3.52

Calculation of NPV

 Alpha Beta Gamma Annual net cash flow 351,145 461,411 717,120 Present value factor 2.991 2.991 2.991 Present value of annual net cash flows 1,050,275 1,380,080 2,144,906 Amount to be invested 1,472,000 5,678,900 2,525,960 Net present value -421,725 -4,298,820 -381,054

#### Earn Coins

Coins can be redeemed for fabulous gifts.