Question

1. Average Rate of Return Method, A method of analysis of proposed capital investments that focuses on the present value of the cash flows expected from the investments.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 operating income and net cash flows from each investment are as follows:

   	Front-End Loader					Greenhouse
   Year	Operating Income		Net Cash Flow			Operating Income		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 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
   Front-End Loader	%
   Greenhouse	%

   1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, round to the nearest dollar. If required, use the minus sign to indicate a negative net present value.

   	Front-End Loader	Greenhouse
   Present value of net cash flow	$	$
   Amount to be invested
   Net present value	$	$

Answer 1

a.
Average rate of return	Average net income/Average investment
Calculation of average rate of return for Front end loader
Average operating income	$55,000	275000/5
Average investment	$250,000	(500000+0)/2
Average rate of return	22.00%
Calculation of average rate of return for Greenhouse
Average operating income	$55,000	275000/5
Average investment	$250,000	(500000+0)/2
Average rate of return	22.00%
b.
Calculation of net present value
Net present value	Present value of cash inflow - Present value of cash outflow
Calculation of NPV for Front end loader
Year	Cash flow	Discount factor @ 15%	Present value
0	-$500,000	1.000	-$500,000
1	$173,000	0.870	$150,510
2	$173,000	0.756	$130,788
3	$173,000	0.658	$113,834
4	$173,000	0.572	$98,956
5	$173,000	0.497	$85,981
Net present value			$80,069
Calculation of NPV for Greenhouse
Year	Cash flow	Discount factor @ 15%	Present value
0	-$500,000	1.000	-$500,000
1	$277,000	0.870	$240,990
2	$234,000	0.756	$176,904
3	$164,000	0.658	$107,912
4	$112,000	0.572	$64,064
5	$78,000	0.497	$38,766
Net present value			$128,636