Question

USE THE FOLLOWING INFORMATION FOR THE NEXT 4 QUESTIONS ABC Company is considering the purchase of a new machine that would cost $500,000. The machine would have a useful life of 10 years. ABC Company plans on using straight-line depreciation with an estimated salvage value of $0. ABC Company has a hurdle rate of 10% and is subject to an income tax rate of 40%. The annual cash income is estimated to be $125.000 PV TABLES CAN BE FOUND ON THE LAST PAGE (11) OF THE EXAMINATION

Answer 1

29. Solution: The correct option is “A” i.e 5.263 years

      Explanation:

      Payback Period: Initial Investment/Annual Cash inflows

      Annual cash Inflows= {($125000-$ 50000)*0.6+$ 50000}=$ 95000

     Initial Investment=$ 500000

     Payback Period=$ 500000/$ 95000=5.263 years

30. Solution: The correct option is “C” i.e 9%

     Explanation:

      Accounting Rate of Return=Annual Net Operating Income/Initial Investment

      Annual Net Operating Income=($125000-$ 50000)*0.6=$ 45000

     Accounting Rate of Return=$ 45000/$ 500000=0.09 i.e 9 %

31. Solution: The correct option is “B” i.e 12% and 14%

      Explanation:

      R1=11% , R2=14%

      Net Present Value @ 11%( NPV1)=5.889*$ 95000-$ 500000=$ 59455

      Net Present Value @ 14%(NPV2)=5.216*$ 95000-$ 500000=-$ 4480

     Internal Rate of Return=R1+NPV1(R2-R1)/(NPV1-NPV2)

      =11%+$ 59455*(3%)/ ($ 59455+$ 4480)=13.79% i.e Between 12% and 14%

    

32. Solution: The correct option is “C” i.e $ 83775

    Explanation:

      Hurdle Rate=10%

      Cummulative PV Factor=6.145

     PV of Cash Inflows =6.145*$ 95000=$ 583775

      PV of Cash Outflow= 1* $ 500000=$ 500000

      Therefore Net Present Value= PV of Cash Inflows- PV of Cash Outflow

       =$ 583775-$ 500000=$ 83775