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 $291,014 $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 The concept that recognizes that a dollar today is worth more than a dollar tomorrow, because today's dollar can earn interest.time value of money No Yes No No Yes No Yes Yes No Yes Yes No Does not consider the time value of money Yes Yes No Yes Yes No No Yes No No Yes No Easy to compute Yes Yes No Yes Yes No No Yes No No Yes No Not as easy to compute No Yes No No Yes No Yes Yes No Yes Yes No Directly considers expected cash flows No Yes No Yes Yes No Yes Yes No Yes Yes No Directly considers timing of expected cash flows No Yes No No Yes No Yes Yes No Yes Yes No Assumes cash flows can be reinvested at minimum desired rate of return No Yes No No Yes No Yes Yes No Yes Yes No Can be used to rank proposals even if project lives are not the same Yes Yes No Yes Yes No No Yes No Yes Yes No

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 $291,014 $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 The concept that recognizes that a dollar today is worth more than a dollar tomorrow, because today's dollar can earn interest.time value of money No Yes No No Yes No Yes Yes No Yes Yes No Does not consider the time value of money Yes Yes No Yes Yes No No Yes No No Yes No Easy to compute Yes Yes No Yes Yes No No Yes No No Yes No Not as easy to compute No Yes No No Yes No Yes Yes No Yes Yes No Directly considers expected cash flows No Yes No Yes Yes No Yes Yes No Yes Yes No Directly considers timing of expected cash flows No Yes No No Yes No Yes Yes No Yes Yes No Assumes cash flows can be reinvested at minimum desired rate of return No Yes No No Yes No Yes Yes No Yes Yes No Can be used to rank proposals even if project lives are not the same Yes Yes No Yes Yes No No Yes No Yes Yes No

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Mastery Problem: Capital Investment Analysis

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	$291,014	$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 The concept that recognizes that a dollar today is worth more than a dollar tomorrow, because today's dollar can earn interest.time value of money	No Yes No	No Yes No	Yes Yes No	Yes Yes No
Does not consider the time value of money	Yes Yes No	Yes Yes No	No Yes No	No Yes No
Easy to compute	Yes Yes No	Yes Yes No	No Yes No	No Yes No
Not as easy to compute	No Yes No	No Yes No	Yes Yes No	Yes Yes No
Directly considers expected cash flows	No Yes No	Yes Yes No	Yes Yes No	Yes Yes No
Directly considers timing of expected cash flows	No Yes No	No Yes No	Yes Yes No	Yes Yes No
Assumes cash flows can be reinvested at minimum desired rate of return	No Yes No	No Yes No	Yes Yes No	Yes Yes No
Can be used to rank proposals even if project lives are not the same	Yes Yes No	Yes Yes No	No Yes No	Yes Yes No

### Average Rate of Return

#### Instructions
You begin by trying to eliminate any proposals that are not yielding the company's minimum required rate of return of 20%. Complete the following table and decide whether Alpha, Beta, and/or Gamma should be eliminated because the average rate of return of their project is less than the company's minimum required rate of return.

Complete the following table. Enter the average rates of return as percentages rounded to two decimal places.

| Proposal | Estimated Average Annual Income | Average Investment | Average Rate of Return | Accept or Reject |
| -------- | ------------------------------- | ------------------ | ---------------------- | ---------------- |
| Alpha | $351,145 | $1,472,000 | 23.86 % | Accept ✅ |
| Beta | $461,411 | $5,678,900 | 8.13 % | Reject ❌ |
| Gamma | $592,819 | $2,125,560 | 27.89 % | Accept ✅ |

In the table above:
- **Estimated Average Annual Income** is the projected annual profit from the proposal.
- **Average Investment** is the initial amount of money invested in the proposal.
- **Average Rate of Return** is calculated by dividing the Estimated Average Annual Income by the Average Investment and then multiplying by 100 to convert to a percentage.
- **Accept or Reject** column indicates whether the proposal meets the minimum requirement of a 20% return rate and should be accepted or rejected accordingly.

This table shows that the Alpha project has an average rate of return of 23.86%, and the Gamma project has a rate of 27.89%; both of these exceed the company's requirement and are accepted. The Beta project, however, has an average rate of return of only 8.13%, falling below the threshold and is therefore rejected.

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