Question

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	$25,000		$ 40,000			$11,250		$ 26,250
2	20,000		35,000			11,250		26,250
3	7,000		22,000			11,250		26,250
4	3,000		18,000			11,250		26,250
5	1,250		16,250			11,250		26,250
Total	$56,250		$131,250			$56,250		$131,250

Each project requires an investment of $75,000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a rate of 12% 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
Greenhouse	%
Front-End Loader	%

1b. Compute the net present value for each investment. Use the present value of $1 table above. If required, round to the nearest dollar.

	Front-End Loader	Greenhouse
Present value of net cash flow	$	$
Amount to be invested
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   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   would be the more attractive.

Answer 1

1a.

	Average Rate of Return
Greenhouse	30.0%
Front-End Loader	30.0%

Working:

Average Rate of Return = Average operating income/Average investment = $11250/$37500 = 30%

Average operating income = $56250/5 years = $11250

Average investment = ($0 + $75000)/2 = $37500

1b.

	Front-End Loader	Greenhouse
Present value of net cash flow	99941	94631
Amount to be invested	75000	75000
Net present value	24941	19631

Working:

Year	PV Factor i=12%	Front-End Loader		Greenhouse
		Net Cash Flow	Present Value	Net Cash Flow	Present Value
1	0.893	40000	35720	26250	23441
2	0.797	35000	27895	26250	20921
3	0.712	22000	15664	26250	18690
4	0.636	18000	11448	26250	16695
5	0.567	16250	9214	26250	14884
Total		131250	99941	131250	94631

2. The front-end loader has a higher 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 front-end loader would be the more attractive.