Question

Hearne Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, management is finding it difficult to compare them.
Project 1: Retooling Manufacturing Facility
This project would require an initial investment of $4,850,000. It would generate $865,000 in additional net cash flow each year. The new machinery has a useful life of eight years and a salvage value of $1,000,000.
Project 2: Purchase Patent for New Product
The patent would cost $3,400,000, which would be fully amortized over five years. Production of this product would generate $425,000 additional annual net income for Hearne.
Project 3: Purchase a New Fleet of Delivery Trucks
Hearne could purchase 25 new delivery trucks at a cost of $115,000 each. The fleet would have a useful life of 10 years, and each truck would have a salvage value of $5,000. Purchasing the fleet would allow Hearne to expand its customer territory resulting in $200,000 of additional net income per year.

Required:
1. Determine each project’s accounting rate of return.
2. Determine each project’s payback period.
3. Using a discount rate of 10 percent, calculate the net present value of each project.
4. Determine the profitability index of each project and prioritize the projects for Hearne.



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  • CreatedFebruary 27, 2015
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