Question

Presented is information pertaining to the cash flows of three mutually exclusive investment proposals:

Proposal X Proposal Y Proposal Z
Initial investment $98,000 $98,000 $98,000
Cash flow from operations
Year 1 90,000 49,000 98,000
Year 2 8,000 49,000
Year 3 49,000 49,000
Disinvestment 0 0 0
Life (years) 3 years 3 years 1 year

(a) Select the best investment proposal using the payback period, the accounting rate of return on initial investment, and the net present value criteria. Assume that the organization's cost of capital is 10 percent.

Round accounting rate of return four decimal places.

Round net present value to the nearest whole number.

Use negative signs with your answers, when appropriate.

Answer 1

The cashflows are uneven for Proposal X, so we have to calculate cummulative cashflows.

Index Proposal X Cummulative cashflows (X)

1st yr 90,000 90,000

2nd yr 8,000 98,000

3rd yr 49,000 1,47,000

Payback period for X:

Since we can able to recover the initial investment at the end of 2nd yr, Payback period for Proposal X is 2 years.

Payback period for Y:

= Initial Investment/Annual cash flows

=98,000/49,000

=2 years

Payback period for Z:

Since we can able to recover the initial investment at the end of the 1st ye itself, Payback period for Proposal Z is 1 year.

Accounting Rate of return:

= Average Profit/Average investment

Average profit = 1st yr cashflow+2nd yr cashflow+3rd yr cashflow/3

Average investment = Initial investment/2

ARR for Proposal X:

=(147000/3)/49000

=1%

ARR for proposal Y:

=(147000/3)/49000

=1%

ARR for Proposal Z:

=98000/49000

=2%

Net Present Value method:

C0 = Initial Investment (98,000)

r = rate of return (10%)

C = year of cashflows

NPV for Proposal X:

= -98,000+(90,000/1.1)+(8,000/1.12)+(49,000/1.13)

=-98,000+81818.18+6611.57+65219

=55648.75

NPV for Proposal Y:

= -98,000+(49,000/1.1)+(49,000/1.12)+(49,000/1.13)

= -98,000+44545.4545+40495.8677+36814.42524

=23855.74

NPV for Proposal Z:

= -98,000+(98,000/1.1)

=-98000-81818.18

=16181.82

Proposal X Proposal Y Proposal Z Best Proposal

Pay back Period 2 years 2 years 1 year Propoasl Z

Average rate of return 1 year 1 year 2 years Proposal Z

Net present Value 55648.75 23855.74 16181.82 Proposal Z

Step-by-step explanation: