Ranking Investment Proposals: Payback Period, Accounting Rate of Return, and Net Present
Value
Presented is information pertaining to the cash flows of three mutually exclusive investment proposals:
............................................................................................Proposal A Propsal B Propsal C
Initial Investment............................................................... 60000 60000 60000
Cash flow from oeprations:
Year 1 50000 30000 60000
Year 2 6000 30000
Year 3 29000 25000
Disinvestment 0 0 0
Life (years) 3 3 1
Required
a. Rank these investment proposals using the payback period, the accounting rate of return on initial
investment, and the net present value criteria. Assume that the organizationâs cost of capital is 12
percent. Round calculations to four decimal places.
b. Explain the difference in rankings. Which investment would you recommend?
Ranking Investment Proposals: Payback Period, Accounting Rate of Return, and Net Present
Value
Presented is information pertaining to the cash flows of three mutually exclusive investment proposals:
............................................................................................Proposal A Propsal B Propsal C
Initial Investment............................................................... 60000 60000 60000
Cash flow from oeprations:
Year 1 50000 30000 60000
Year 2 6000 30000
Year 3 29000 25000
Disinvestment 0 0 0
Life (years) 3 3 1
Required
a. Rank these investment proposals using the payback period, the accounting rate of return on initial
investment, and the net present value criteria. Assume that the organizationâs cost of capital is 12
percent. Round calculations to four decimal places.
b. Explain the difference in rankings. Which investment would you recommend?
Related questions
Renaissance Capital Group is considering allocating a limitedamount of capital investment funds among four proposals. The amountof proposed investment, estimated income from operations, and netcash flow for each proposal are as follows:
| Investment | Year | Income from Operations | Net Cash Flow | |||
| Proposal A: | $680,000 | 1 | $ 64,000 | $ 200,000 | ||
| 2 | 64,000 | 200,000 | ||||
| 3 | 64,000 | 200,000 | ||||
| 4 | 24,000 | 160,000 | ||||
| 5 | 24,000 | 160,000 | ||||
| $240,000 | $ 920,000 | |||||
| Proposal B: | $320,000 | 1 | $ 26,000 | $ 90,000 | ||
| 2 | 26,000 | 90,000 | ||||
| 3 | 6,000 | 70,000 | ||||
| 4 | 6,000 | 70,000 | ||||
| 5 | (44,000) | 20,000 | ||||
| $ 20,000 | $340,000 | |||||
| Proposal C: | $108,000 | 1 | $ 33,400 | $ 55,000 | ||
| 2 | 31,400 | 53,000 | ||||
| 3 | 28,400 | 50,000 | ||||
| 4 | 25,400 | 47,000 | ||||
| 5 | 23,400 | 45,000 | ||||
| $142,000 | $ 250,000 | |||||
| Proposal D: | $400,000 | 1 | $100,000 | $ 180,000 | ||
| 2 | 100,000 | 180,000 | ||||
| 3 | 80,000 | 160,000 | ||||
| 4 | 20,000 | 100,000 | ||||
| 5 | 0 | 80,000 | ||||
| $300,000 | $700,000 |
The company's capital rationing policy requires a maximum cashpayback period of three years. In addition, a minimum average rateof return of 12% is required on all projects. If the precedingstandards are met, the net present value method and present valueindexes are used to rank the remaining proposals.
| Present Value of $1 at CompoundInterest | |||||
| 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:
1. Compute the cash payback period for each ofthe four proposals.
| Cash Payback Period | |
| Proposal A | |
| Proposal B | |
| Proposal C | |
| Proposal D |
2. Giving effect to straight-line depreciationon the investments and assuming no estimated residual value,compute the average rate of return for each of the four proposals.If required, round your answers to one decimal place.
| Average Rate of Return | |
| Proposal A | % |
| Proposal B | % |
| Proposal C | % |
| Proposal D | % |
3. Using the following format, summarize theresults of your computations in parts (1) and (2) by placing thecalculated amounts in the first two columns on the left andindicate which proposals should be accepted for further analysisand which should be rejected. If required, round your answers toone decimal place.
| Proposal | Cash Payback Period | Average Rate of Return | Accept or Reject | |
| A | % | |||
| B | % | |||
| C | % | |||
| D | % | |||
4. For the proposals accepted for furtheranalysis in part (3), compute the net present value. Use a rate of15% and the present value of $1 table above. Round to the nearestdollar.
| Select the proposal accepted for further analysis. | ||
| Present value of net cash flow total | $ | $ |
| Less amount to be invested | $ | $ |
| Net present value | $ | $ |
5. Compute the present value index for each ofthe proposals in part (4). If required, round your answers to twodecimal places.
| Select proposal to compute Present value index. | ||
| Present value index (rounded) |
6. Rank the proposals from most attractive toleast attractive, based on the present values of net cash flowscomputed in part (4).
| Rank 1st | |
| Rank 2nd |
7. Rank the proposals from most attractive toleast attractive, based on the present value indexes computed inpart (5).
| Rank 1st | |
| Rank 2nd |
8. The present value indexes indicate thatalthough Proposal has the larger net present value, it is not asattractive as Proposal in terms of the amount of present value perdollar invested. Proposal requires the larger investment. Thus,management should use investment resources for Proposal beforeinvesting in Proposal , absent any other qualitative considerationsthat may impact the decision.
Drake Corporation is reviewing an investment proposal. Theinitial cost and estimates of the book value of the investment atthe end of each year, the net cash flows for each year, and the netincome for each year are presented in the schedule below. All cashflows are assumed to take place at the end of the year. The salvagevalue of the investment at the end of each year is equal to itsbook value. There would be no salvage value at the end of theinvestmentâs life.
| Investment Proposal | ||||||||||
| Year | Initial Cost and Book Value | Annual Cash Flows | Annual Net Income | |||||||
| 0 | $105,000 | |||||||||
| 1 | 70,000 | $45,000 | $10,000 | |||||||
| 2 | 42,000 | 40,000 | 12,000 | |||||||
| 3 | 21,000 | 35,000 | 14,000 | |||||||
| 4 | 7,000 | 30,000 | 16,000 | |||||||
| 5 | 0 | 25,000 | 18,000 | |||||||
Drake Corporation uses an 11% target rate of return for newinvestment proposals.
What is the cash payback period for this proposal?____ years
What is the annual rate of return for the investment?____%
What is the net present value of the investment?$ _____
