Capital Rationing Decision for a Service Company 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:
| Investment | Year | Income from Operations | Net Cash Flow | |||
| Proposal A: | $680,000 | 1 | $64,000 | $200,000 | ||
| 2 | 64,000 | 200,000 | ||||
| 3 | 64,000 | 200,000 | ||||
| 4 | 24,000 | 160,000 | ||||
| 5 | 24,000 | 160,000 | ||||
| $240,000 | $920,000 | |||||
| Proposal B: | $320,000 | 1 | $26,000 | $90,000 | ||
| 2 | 26,000 | 90,000 | ||||
| 3 | 6,000 | 70,000 | ||||
| 4 | 6,000 | 70,000 | ||||
| 5 | (44,000) | 20,000 | ||||
| $20,000 | $340,000 | |||||
| Proposal C: | $108,000 | 1 | $33,400 | $55,000 | ||
| 2 | 31,400 | 53,000 | ||||
| 3 | 28,400 | 50,000 | ||||
| 4 | 25,400 | 47,000 | ||||
| 5 | 23,400 | 45,000 | ||||
| $142,000 | $250,000 | |||||
| Proposal D: | $400,000 | 1 | $100,000 | $180,000 | ||
| 2 | 100,000 | 180,000 | ||||
| 3 | 80,000 | 160,000 | ||||
| 4 | 20,000 | 100,000 | ||||
| 5 | 0 | 80,000 | ||||
| $300,000 | $700,000 |
The company's capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average
| Present Value of $1 at |
|||||
| 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 |
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
| Average Rate of Return | |
| Proposal A: | % |
| Proposal B: | % |
| Proposal C: | % |
| Proposal D: | % |
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.
Note: Select the proposals in alphabetic order.
| Select the proposal accepted for further analysis. | ||
| Present value of net cash flow total | $ | $ |
| Less amount to be invested | $ | $ |
| Net present value | $ | $ |
5. Compute the present value index for each of the proposals in part (4). If required, round your answers to two decimal places.
Note: Select the proposals in alphabetic order.
| Select proposal to compute Present value index. | ||
| Present value index (rounded) |
6. Rank the proposals from most attractive to least attractive, based on the present values of net cash flows computed in part (4).
| Rank 1st | |
| Rank 2nd |
7. Rank the proposals from most attractive to least attractive, based on the present value indexes computed in part (5).
| Rank 1st | |
| Rank 2nd |
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.
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