Vanessa Company is evaluating two projects. project 1 is a project requiring a capital expenditure of 814,400. the project has an estimated life of four years and no salvage value. The estimated net income and net cash flow from the project are as follows:

Year Net income Net cash flow

1 90,000 210,000
2 80,000 200,000
3 40,000 160,000
4 30,000 150,000
5 240,000 720,000

Companys minimum desired rate or returen for net present value analysis is 15 %. The present value of the $1 at compound intrest of 15% for 1,2,3,4 years is 0.870 0.756 0.658 and 0.572. Determine the average rate of return on investment using straight line method and net present value.

The average rate of return on investment using:

 + Straight line method: 23.58%

 + Net present value: 17.85%

Explanation:

* The average rate of return on investment using straight line method:

We have Average rate of return = Average net profit/ Average investment

with average net profit = (90,000 + 80,000 + 40,000 + 30,000 + 240,000)/5 = $96,000

       average investment: (investment at the beginning + investment of the end) /2 = 814,400/2 = 407,200

=> Average rate of return = 96,000 / 407,200 = 23.58%

* The average rate of return on investment using net present value:

The average rate of return is the internal rate of return on the project which is the rate that brings the net present value to zero.

Denote the rate as x => (1+x)^(-t) is the discount rate of year t. Denote 1+x as a, we have:

-814,400 + 210,000/a + 200,000/a^2 + 160,000/a^3 + 150,000/a^4 + 720,000/a^5 = 0 <=> a = 1.1785

=> x = 17.85%

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