A company is evaluating 3 possible investments. Each uses straight-line depreciation. See data below: What is the rate of return for Project C?

Question

A company is evaluating 3 possible investments. Each uses straight-line depreciation. See data below:  What is the rate of return for Project C?

Quizplus · Accepted Answer

To calculate the rate of return, we need to find the total net cash flows (the sum of the cash inflows and outflows for each year), and then find the present value of those cash flows using the given discount rate of 10%. Then we can use the formula:

Rate of return = (Total present value of cash flows / Initial investment)^(1/n) - 1

For Project C: 
Initial investment = $50,000 
Annual net cash flows = $15,000 
Discount rate = 10%

Year 0: 
Initial investment = -$50,000

Year 1: 
Cash inflow = $15,000 
Depreciation = $10,000 
Net cash flow = $5,000 
Present value = $4,545

Year 2: 
Cash inflow = $15,000 
Depreciation = $10,000 
Net cash flow = $5,000 
Present value = $4,132

Year 3: 
Cash inflow = $15,000 
Depreciation = $10,000 
Net cash flow = $5,000 
Present value = $3,757

Year 4: 
Cash inflow = $15,000 
Depreciation = $10,000 
Net cash flow = $5,000 
Present value = $3,416

Year 5: 
Cash inflow = $15,000 
Depreciation = $5,000 
Net cash flow = $10,000 
Present value = $7,115

Total present value of cash flows = $23,965

Rate of return = ($23,965 / $50,000)^(1/5) - 1 = 0.05 = 5%

Therefore, the rate of return for Project C is 5%.

As for the best choice, it depends on the company's goals and constraints. If the company is looking for the highest rate of return, then Project C is the best choice as it has the highest rate of return among the three options. However, if the company has limited funds and needs to prioritize projects with a shorter payback period, then Project A may be the best choice as it has the shortest payback period among the three options.

A Company Is Evaluating 3 Possible Investments