Capital Rationing Decision for a Service Company Involving FourProposals
Renaissance Capital Group is considering allocating a limitedamount of capital investment funds among four proposals. The amountof proposed investment, estimated income from operations, and netcash flow for each proposal are as follows:
| Investment | Year | | Income from Operations | | Net CashFlow |
| 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 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 | 3 years 6 months |
| Proposal B | 4 years |
| Proposal C | 2 years |
| Proposal D | 2 years 3 months |
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 decimal place.
| 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 your answers toone decimal place.
| Proposal | Cash Payback Period | Average Rate of Return | Accept or Reject |
| A | 3 years, 6 months | % | | Reject |
| B | 4 years | % | | Reject |
| C | 2 years | % | | Accept |
| D | 2 years, 3 months | % | | Accept |
4. For the proposals accepted for furtheranalysis in part (3), compute the net present value. Use a rate of15% and the present value of $1 table above. Round to the nearestdollar.
| Select the proposal accepted for further analysis. | Proposal C | Proposal D |
| Present value of net cash flow total | $ | $ |
| Less amount to be invested | $ | $ |
| Net present value | $ | $ |
5. Compute the present value index for each ofthe proposals in part (4). If required, round your answers to twodecimal places.
| Select proposal to compute Present value index. | Proposal C | Proposal D |
| Present value index (rounded) | | |
