Question 4

Mastery Problem: Capital Investment Analysis

Question Content Area

HomeGrown Company

HomeGrown Company is a chain of grocery stores that are similar to indoor farmer's markets, providing fresh, local produce, meats, and dairy products to consumers in urban areas. HomeGrown is considering opening several stores in a new city, and has proposals from three contractors (Alpha, Beta, and Gamma companies) who would like to provide buildings for the new stores.

The amount of expected revenue from the stores will depend on the design of the contractor. For example, if HomeGrown decides on a more open floor plan, with less shelf space for products, revenue would be lower overall. However, if HomeGrown decides on a very crowded floor plan, it may lose customers who appreciate a more open feel.

As the project manager for HomeGrown, you are responsible for deciding which if any of the proposals to accept. HomeGrown's minimum acceptable rate of return is 20%. You receive the following data from the three contractors:

Proposal	Type of Floor Plan	Initial Cost if Selected	Residual Value
Alpha	Very open, like an indoor farmer's market	$1,472,000	$0.00
Beta	Standard grocery shelving and layout, minimal aisle space	5,678,900	0.00
Gamma	Mix of open areas and shelving areas	2,125,560	0.00

You have computed estimates of annual cash flows and average annual income from customers for each of the three contractors' plans. You believe that the annual cash flows will be equal for each of the 10 years for which you are preparing your capital investment analysis. Your conclusions are presented in the following table.

Proposal	Estimated Average Annual Income (after depreciation)	Estimated Average Annual Cash Flow
Alpha	$302,054	$351,145
Beta	272,019	461,411
Gamma	527,245	592,819

Method Comparison

Compare methods of capital investment analysis in the following table to begin your evaluation of the three capital investment proposals Alpha, Beta, and Gamma. You decide to compare four methods: the average rate of return, cash payback period, net present value, and internal rate of return methods.

	Average Rate of Return Method	Cash Payback Method	Net Present Value Method	Internal Rate of Return Method
Considers the time value of money	YesNo	YesNo	YesNo	YesNo
Does not consider the time value of money	YesNo	YesNo	YesNo	YesNo
Easy to compute	YesNo	YesNo	YesNo	YesNo
Not as easy to compute	YesNo	YesNo	YesNo	YesNo
Directly considers expected cash flows	YesNo	YesNo	YesNo	YesNo
Directly considers timing of expected cash flows	YesNo	YesNo	YesNo	YesNo
Assumes cash flows can be reinvested at minimum desired rate of return	YesNo	YesNo	YesNo	YesNo
Can be used to rank proposals even if project lives are not the same	YesNo	YesNo	YesNo	YesNo