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16. Over the River Manufacturing purchased a machine for $394,000 with an expected useful life of 5 years and expected salvag
18. Quilt Appraisers is considering purchasing two machines. Each machine costs $33,000, has 3-year useful life, with a $5,00
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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

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