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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883

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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883
Textbook Problem

Average rate of return method, net present value method, and analysis

The capital investment committee of Overnight Express Inc. is considering two investmentprojects. The estimated income from operations and net cash flows from each investmentare as follows:

Each project requires an investment of $800.000. Straight-line depreciation will be used, and no residual value is expected. The committee has selected a r.ne of 15% for purposes of the net present value analysis.

Instructions
Prepare a brief report for the capital investment committee, advising it on the relative meritsof the two projects.

To determine

Concept introduction:

Average rate of return:

The average rate of return is the method to determine average income over the period in regard to the investment made in that period.

Net present value method:

It is a method of determining the present value of cash flows over the period by the multiplying the cash flows with the discounting factor of the required rate.

The brief report on the investment and relative merits of each project.

Explanation

The report, in brief, on the investment made is that both the projects have same return i.e. 16.5% and same life and cost of investment in the project but has different cash flow structure which provides different net present value of each project.

The relative merits are:

The project which has positive and higher NPV should be selected

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