Capital Rationing Decision Inv

Capital Rationing Decision Involving Four Proposals

Kopecky Industries Inc. 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 fromOperations Net CashFlows
Proposal Sierra: $850,000 1 $ 80,000 $ 250,000
2 80,000 250,000
3 80,000 250,000
4 30,000 200,000
5 (70,000) 100,000
$200,000 $ 1,050,000
Proposal Tango: $1,200,000 1 $320,000 $ 560,000
2 320,000 540,000
3 160,000 400,000
4 60,000 300,000
5 (40,000) 220,000
$820,000 $2,020,000
Proposal Uniform: $550,000 1 $ 90,000 $ 200,000
2 90,000 200,000
3 90,000 200,000
4 90,000 200,000
5 70,000 180,000
$430,000 $ 980,000
Proposal Victor: $380,000 1 $44,000 $ 120,000
2 44,000 120,000
3 44,000 120,000
4 4,000 80,000
5 4,000 80,000
$140,000 $ 520,000

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. 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.Round to one decimal place.

Average Rate of Return
Proposal Sierra %
Proposal Tango %
Proposal Uniform %
Proposal Victor %

2. For the proposals accepted for furtheranalysis in part (3), compute the net present value. Use a rate of12% and the present value of $1 table above. If required, use theminus sign to indicate a negative net present value.

Select the proposal accepted for further analysis. Proposal Tango Proposal Uniform
Present value of net cash flow total $ $
Amount to be invested
Net present value $ $

3. Compute the present value index for each ofthe proposals in part (4). Round to two decimal places.

Select the proposal to compute present value index. Proposal Tango Proposal Uniform
Present value index (rounded)

Answer:

Proposal Sierra

Proposal Tango

Proposal Uniform

Proposal Victor

Year

income form operations

Year

income form operations

Year

income form operations

Year

income form operations

1

80000

1

320000

1

90000

1

44000

2

80000

2

320000

2

90000

2

44000

3

80000

3

160000

3

90000

3

44000

4

30000

4

60000

4

90000

4

4000

5

-70000

5

-40000

5

70000

5

4000

Average income from operation = (200000/5)

40000

Average income from operation = (200000/5)

164000

Average income from operation = (200000/5)

86000

Average income from operation = (200000/5)

28000

Initial Investment

850000

Initial Investment

1200000

Initial Investment

550000

Initial Investment

380000

Average rate of return = average income from operation/initialinvestment

4.71%

Average rate of return = average income from operation/initialinvestment

13.67%

Average rate of return = average income from operation/initialinvestment

15.64%

Average rate of return = average income from operation/initialinvestment

7.37%

Project Sierra and proposal Victor would be dropped as ARR isless than the required rate of 12%

Proposal Tango

Proposal Uniform

Year

net operating cash flow

present value of cash inflow

Year

net operating cash flow

present value of cash inflow

0

-1200000

0

-550000

1

560000

500000

1

200000

178571.4

2

540000

446428.57

2

200000

159438.8

3

400000

284712.1

3

200000

142356

4

300000

190655.42

4

200000

127103.6

5

220000

124833.91

5

180000

102136.8

sum of present value of cash inflow

1546630

sum of present value of cash inflow

709606.7

less cash outflow

1200000

less cash outflow

550000

NPV

346630

NPV

159606.7

PI

sum of present value of cash inflow/cash outflow

1.29

PI

sum of present value of cash inflow/cash outflow

1.29


 
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