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PR26-6B Empire

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Empire Capital Group is considering allocating a limited amount of capital investment
funds among four proposals. The amount of proposed investment, estimated income
from operations, and net cash flow for each proposal are as follows:


  Investment Year Income from Operation Net Cash flow
 Proposal A:   420,000  1  86,000  170,000
   2  46,000  130,000
   3  16,000  100,000
   4  (4,000)  80,000
   5  (4,000)  80,000
   140,000  560,000
 
 Proposal B:   850,000  1  130,000  300,000
   2  130,000  300,000
   3  130,000  300,000
   4  130,000  300,000
   5  80,000  250,000
   600,000  1,450,000
 
 Proposal C:   250,000  1  20,000  70,000
   2  20,000  70,000
   3  20,000  70,000
   4  (10,000)  40,000
   5  (10,000)  40,000
   40,000  290,000
 
 Proposal D:   180,000  1  54,000  90,000
   2  24,000  60,000
   3  24,000  60,000
   4  14,000  50,000
   5  14,000  50,000
   130,000  310,000

The company’s capital rationing policy requires a maximum cash payback period
of three years. In addition, a minimum average rate of return of 12% is required on all

projects. If the preceding standards are met, the net present value method and present
value indexes are used to rank the remaining proposals.

Instructions
1. Compute the cash payback period for each of the four proposals.

2. Giving effect to straight-line depreciation on 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.

3. Using the following format, summarize the results of your computations in parts (1)
and (2). By placing the calculated amounts in the first two columns on the left and by
placing a check mark in the appropriate column to the right, indicate which proposals
should be accepted for further analysis and which should be rejected.

Cash Payback Average Rate Accept for
Proposal Period of Return Further Analysis Reject
A
B
C
D

4. For the proposals accepted for further analysis in part (3), compute the net present
value. Use a rate of 15% and the present value of $1 table appearing in this chapter.
Round to the nearest dollar.

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

6. Rank the proposals from most attractive to least attractive, based on the present
values of net cash flows computed in part (4).

7. Rank the proposals from most attractive to least attractive, based on the present
value indexes computed in part (5).

8. Based on the analyses, comment on the relative attractiveness of the
proposals ranked in parts (6) and (7).

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