HomeGrown Company is a chain of grocery stores that are similar to indoor farmer's markets, providing fresh, local produce, meats, and dairy products to consumers in urban areas. HomeGrown is considering opening several stores in a new city, and has proposals from three contractors (Alpha, Beta, and

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Chapter1: Financial Statements And Business Decisions
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HomeGrown Company is a chain of grocery stores that are similar to indoor farmer's markets, providing fresh, local produce, meats, and dairy products to consumers in urban areas. HomeGrown is considering opening several stores in a new city, and has proposals from three contractors (Alpha, Beta, and Gamma companies) who would like to provide buildings for the new stores.

The amount of expected revenue from the stores will depend on the design of the contractor. For example, if HomeGrown decides on a more open floor plan, with less shelf space for products, revenue would be lower overall. However, if HomeGrown decides on a very crowded floor plan, it may lose customers who appreciate a more open feel.

As the project manager for HomeGrown, you are responsible for deciding which if any of the proposals to accept. HomeGrown's minimum acceptable rate of return is 20%. You receive the following data from the three contractors:

Proposal

Type of Floor Plan

Initial Cost if Selected

Residual Value

Alpha

Very open, like an indoor farmer’s market

$1,472,000

$0.00

Beta

Standard grocery shelving and layout, minimal aisle space

5,678,900

0.00

Gamma

Mix of open areas and shelving areas

2,525,960

0.00

You have computed estimates of annual cash flows and average annual income from customers for each of the three contractors' plans. You believe that the annual cash flows will be equal for each of the 10 years for which you are preparing your capital investment analysis. Your conclusions are presented in the following table.

Proposal

Estimated Average

 

Annual Income

Estimated Average

(after depreciation)

Annual Cash Flow

Alpha

$313,094

$351,145

Beta

272,019

461,411

Gamma

620,249

717,120

You begin by trying to eliminate any proposals that are not yielding the company’s minimum required rate of return of 20%. Complete the following table, and decide whether Alpha, Beta, and/or Gamma should be eliminated because the average rate of return of their project is less than the company's minimum required rate of return.

Complete the following table. Enter the average rates of return as percentages rounded to two decimal places.

Proposal

Estimated Average Annual Income

Average Investment

Average Rate of Return

Accept or Reject?

Alpha

       

Beta

       

Gamma

       

 

You’ve decided to confirm your results from the average rate of return by using the cash payback method.

 

Using the following table, compute the cash payback period of each investment. If required, round the number of years in the cash payback period to a whole number.

 

Proposal

Initial Cost

Annual Net Cash Inflow

Cash Payback Period in Years

Alpha

     

Beta

     

Gamma

     

Even though you’re fairly certain that your evaluation and elimination is correct, you would like to compare the three proposals using the net present value method, and get some data about the internal rate of return of the proposals, each of which are expected to generate their respective annual net cash inflows for a period of 10 years.

Compute the net present value of each proposal. You may need the following partial table of factors for the present value of an annuity of $1. Enter amounts that represent cash outflows as negative numbers using a minus sign. Round the present value of annual net cash flows to the nearest dollar.

 

Present Value of an Annuity of $1 at Compound Interest (Partial Table)

Year

10%

20%

1

0.909

0.833

5

3.791

2.991

10

6.145

4.192

 

 

Alpha

Beta

Gamma

Annual net cash flow

     

Present value factor

     

Present value of annual cash flow

     

Amount to be invested

     

Net present value

     

 

 

 

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