Average Rate of Return Method Net Present Value Method and A

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:

Each project requires an investment of $420,000. 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. If required, round your answer to one decimal place.

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.

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 smaller 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 greenhouse would be the more attractive.

	Front-End Loader		Greenhouse
Year	Income from Operations	Net Cash Flow		Income from Operations	Net Cash Flow
1	$42,000		$137,000			$88,000		$219,000
2	42,000		137,000			67,000		185,000
3	42,000		137,000			34,000		130,000
4	42,000		137,000			15,000		89,000
5	42,000		137,000			6,000		62,000
Total	$210,000		$685,000			$210,000		$685,000

Solution

Req 1-a: Fron end Loader Greenhouse Total income 210000 210000 Average income 42000 42000 Total Investment 420000 420000 Average Investment 210000 210000 Avarage rate of return 20% 20% Req 1-b: Front end Greenhouse Year PVF @ 15% Cash fows Present value Cash fows Present value 1 0.869565 137000 119130.4 219000 190434.8 2 0.756144 137000 103591.7 185000 139886.6 3 0.657516 137000 90079.72 130000 85477.11 4 0.571753 137000 78330.19 89000 50886.04 5 0.497177 137000 68113.21 62000 30824.96 Present value of inflows 459245 497510 Less: Initial investment 420000 420000 NPV 39245 77510 The front end loader has a smaller net present value because cash flows occur later in time as compared to Greenhouse. Thus if onlly one of the project can be accepted, the Greenhouse would be more accepted.