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 |