Capital Rationing Decision for a Service Company Involving FourProposals

Clearcast Communications Inc. is considering allocating alimited amount of capital investment funds among four proposals.The amount of proposed investment, estimated Operating income, andnet cash flow for each proposal are as follows:

	Investment	Year		Operating Income		Net Cash Flow
Proposal A:	$450,000	1		$30,000		$120,000
		2		30,000		120,000
		3		20,000		110,000
		4		10,000		100,000
		5		(30,000)		60,000
				$60,000		$510,000
Proposal B:	$200,000	1		$60,000		$100,000
		2		40,000		80,000
		3		20,000		60,000
		4		(10,000)		30,000
		5		(20,000)		20,000
				$90,000		$290,000
Proposal C:	$320,000	1		$36,000		$100,000
		2		26,000		90,000
		3		26,000		90,000
		4		16,000		80,000
		5		16,000		80,000
				$120,000		$440,000
Proposal D:	$540,000	1		$92,000		$200,000
		2		72,000		180,000
		3		52,000		160,000
		4		12,000		120,000
		5		(8,000)		100,000
				$220,000		$760,000

The company's capital rationing policy requires a maximum cashpayback period of three years. In addition, a minimum average rateof return of 12% is required on all projects. If the precedingstandards are met, the net present value method and present valueindexes are used to rank the remaining proposals.

Present Value of $1 at CompoundInterest
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 ofthe four proposals.

	Cash Payback Period
Proposal A:
Proposal B:
Proposal C:
Proposal D:

2. Giving effect to straight-line depreciationon 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 decimalplace.

	Average Rate of Return
Proposal A:	%
Proposal B:	%
Proposal C:	%
Proposal D:	%

3. Using the following format, summarize theresults of your computations in parts (1) and (2). By placing thecalculated amounts in the first two columns on the left andindicate which proposals should be accepted for further analysisand which should be rejected. If required, round youranswers 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 furtheranalysis in part (3), compute the net present value. Use a rate of12% and the present value of $1 table above. Round to thenearest dollar.

Select the proposal accepted for further analysis.
Present value of net cash flow total	$	$
Amount to be invested
Net present value	$	$

5. Compute the present value index for each ofthe proposals in part (4). If required, round your answersto two decimal places.

Select proposal to compute Present value index.
Present value index (rounded)

6. Rank the proposals from most attractive toleast attractive, based on the present values of net cash flowscomputed in part (4).

Rank 1st
Rank 2nd

7. Rank the proposals from most attractive toleast attractive, based on the present value indexes computed inpart (5).

Rank 1st
Rank 2nd

8. The analysis indicates that althoughProposal   has the larger net present value, it isnot as attractive as Proposal   in terms of theamount of present value per dollar invested.Proposal   requires the larger investment. Thus,management should use investment resources forProposal   before investing in Proposal  ,absent any other qualitative considerations that may impact thedecision.