capital investment analysis problem 458781

Plasticon manufactures plastic containers used to package a variety of liquid consumer products (such as fabric softener, cleaners, and shampoo, hair spray, and liquid soap). The containers are manufactured on a job-order basis to customer specifications.

Plasticon has received five proposals for capital investment projects. Your job is to evaluate these proposals and rank them in the order in which they should be funded. Begin your analysis by computing the average rate of return and the payback period for each proposal. Any project that has an average rate of return of less than 15% or a payback period of longer than 5 years should be eliminated from further consideration. After this initial screening, compute the net present value (using a 15% discount rate) and internal rate of return for the remaining projects. Rank the projects, based on both their profitability and overall merit to the corporation (qualitative factors).

Projects A B C D E

Cost$200,000 $250,000 $325,000 $500,000 $400,000

Life (in years) 8 10 10 10 8

residual value $0 $0 $0 $0 $0

Annual project net income $17,000 $18,000 $33,000 $55,000 $45,000

Annual net cash flows $42,000 $43,000 $65,500 $105,000 $95,000

Project A: This proposal requests funds to purchase hardware and software that will allow the Accounting Department to process payroll in-house. Paychecks are currently processed by an outside payroll service company. The annual increase in net income and cash flows will result from cost savings if the payroll function is no longer contracted to an outside company.

Project B: This proposal requests funds for new manufacturing equipment. This equipment will allow Plasticon to make containers as large as 10 gallons. Currently, Plasticon cannot make containers that are larger than 3 gallons.

Project C: This proposal requests funds for equipment to make stick-on labels that are applied to the plastic containers. Currently, all stick-on labels are ordered from another company. This supplier has not proven very reliable in meeting delivery deadlines.

Project D: This proposal requests funds for automated manufacturing equipment that will reduce the cycle time from receipt of a customer order to delivery of that order. Plasticon’s cycle time is currently days. The automated equipment will reduce that time to 4 days, while saving costs due to the elimination of five jobs. It will also make Plasticon more competitive; the company’s major competitor currently has a cycle time of 5 days.

Project E: This proposal requests funds for computerized drafting and design equipment that will allow engineers to complete manufacturing instructions on special orders more quickly. This equipment should reduce Plasticon’s cycle time from 7 to 5 days.

Present Value of an Annuity of $1 Compound Interest

Period 12% 13% 14% 15% 16% 17% 18%

8 4.968 4.799 4.639 4.487 4.344 4.207 4.078

10 5.650 5.426 5.216 5.019 4.833 4.659 4.494

answer:

CAPITAL RATIONING

Projects

A B C D E

Average rate of return

Payback period

Net present value

Internal rate of return

Which Project do you recommend and why?