Question

Please Answer these Question in Box and show and you got the numbers.

16. Over the River Manufacturing purchased a machine for $394,000 with an expected useful life of 5 years and expected salvage value of $24,000. Over the River anticipates a yearly after-tax income of $53,000, earned evenly throughout the year. What is the accounting rate of return on this machine? 17. Puddle Jumper Productions is considering a 4-year project, planning to invest $56,000 now and forecasting cash flows for each year of $18,000. The CEO requires a hurdle rate of 10%. Should this project be accepted? Internal rate of return Accept or Reject Project? Reasoning?

Answer 1

16.

Accounting Rate of Return of the machine is 25.36 %

Explanation:

Accounting Rate of Return = Average net profit/Average investment

                                            = $ 53,000/ [($ 394,000 + $ 24,000)/2]

                                            = $ 53,000/4/ ($ 418,000/2)

                                            = $ 53,000/ $ 209,000

                                            = 0.25358851674641 or 25.36 %

17.

Internal rate of return	10.87 %
Accept or reject the Project? Reasoning?	Accept the project as IRR is higher than required hurdle rate.

Explanation:

Computation of IRR using trial and error method:

Let’s compute NPV at discount rate of 10 %

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 10% (F)	PV (C x F)
0	($56,000)	1/ (1+0.1)0	1	($56,000.00)
1	$18,000	1/ (1+0.1)1	0.9090909090909	$16,363.64
2	$18,000	1/ (1+0.1)2	0.8264462809917	$14,876.03
3	$18,000	1/ (1+0.1)3	0.7513148009016	$13,523.67
4	$18,000	1/ (1+0.1)4	0.6830134553651	$12,294.24
			NPV1	$1,057.58

As NPV is positive, Let’s compute NPV at discount rate of 11 %

Year	Cash Flow (C)	Computation of PV Factor	PV Factor @ 11% (F)	PV (C x F)
0	($56,000)	1/ (1+0.11)0	1	($56,000.00)
1	$18,000	1/ (1+0.11)1	0.9009009009009	$16,216.22
2	$18,000	1/ (1+0.11)2	0.8116224332441	$14,609.20
3	$18,000	1/ (1+0.11)3	0.7311913813010	$13,161.44
4	$18,000	1/ (1+0.11)4	0.6587309741450	$11,857.16
			NPV2	($155.98)

IRR = R₁ + [NPV₁ x (R₂ -R₁) %/ (NPV₁ – NPV₂)

       = 10 % + [$ 1,057.58 x (11 % - 10 %)/ [$ 1,057.58 – (-$ 155.98)]

       = 10 % + ($ 1,057.58 x 0.01)/ ($ 1,057.58 + $ 155.98)

       = 10 % + ($ 10.5758 / $ 1,213.56)

       = 10 % + 0.008714690662184

       = 10 % + 0.8714690662184 %

        = 10.87 %

18.

NPV of machine 1 is $ 450.26

NPV of machine 2 is $ 1,782.71

Based on NPV decision rule, machine 2 should be selected as it has higher NPV than machine 1.

Explanation:

NPV = PV of future cash flows – Initial investment

Cash flow for machine 1 in year 3 = Annual cash flow + Salvage value = $ 23,000 + $ 5,000 = $ 28,000

Cash flow for machine 2 in year 3 = Annual cash flow + Salvage value = $ 13,000 + $ 5,000 = $ 18,000

			Machine 1		Machine 2
Year	Computation of PV Factor	PV Factor @ 12% (F)	Cash Flow (C1)	PV (C1 x F)	Cash Flow (C2)	PV (C2 x F)
0	1/ (1+0.12)0	1	($33,000)	($33,000.00)	($33,000)	($33,000.00)
1	1/ (1+0.12)1	0.892857142857143	$8,000	$7,142.86	$13,000	$11,607.14
2	1/ (1+0.12)2	0.797193877551020	$8,000	$6,377.55	$13,000	$10,363.52
3	1/ (1+0.12)3	0.711780247813411	$28,000	$19,929.85	$18,000	$12,812.04
			NPV1	$450.26	NPV2	$1,782.71