|
Capital
Rationing Decision Involving Four Proposals
Renaissance
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:
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.
|
Present Value of $1 at Compound Interest
|
|
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.
Compute the cash payback period
for each of the four proposals.
|
|
Cash Payback Period
|
|
Proposal
A
|
|
|
Proposal
B
|
|
|
Proposal
C
|
|
|
Proposal
D
|
|
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. If
required, round your answers 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 indicate
which proposals should be accepted for further analysis and which should be
rejected. If required, round your answers to one decimal place.
|
Proposal
|
Cash Payback Period
|
Average Rate of Return
|
Accept or 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 above. Round to the nearest dollar.
5.
Compute the present value index
for each of the proposals in part (4). If required, round your answers 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.
The present value indexes indicate
that although Proposal has the larger net present value, it is not as
attractive as Proposal in terms of the amount of present value per dollar
invested. Proposal requires the larger investment. Thus, management should
use investment resources for Proposal before investing in Proposal , absent
any other qualitative considerations that may impact the decision.
|