Question

Rundle Electronics is considering investing in manufacturing equipment expected to cost $320,000. The equipment has an estimated useful life of four years and a salvage value of $ 19,000. It is expected to produce incremental cash revenues of $160,000 per year. Rundle has an effective income tax rate of 30 percent and a desired rate of return of 12 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Required a. Determine the net present value and the present value index of the investment, assuming that Rundle uses straight- line depreciation for financial and income tax reporting. b. Determine the net present value and the present value index of the investment, assuming that Rundle uses double- declining-balance depreciation for financial and income tax reporting. d. Determine the payback period and unadjusted rate of return (use average investment), assuming that Rundle uses straight-line depreciation. e. Determine the payback period and unadjusted rate of return (use average investment), assuming that Rundle uses double-declining-balance depreciation. (Note: Use average annual cash flow when computing the payback period and average annual income when determining the unadjusted rate of return.) Complete this question by entering your answers in the tabs below. Req A and Req D and В E Determine the net present value and the present value index of the investment, assuming that Harper uses straight- line depreciation and double-declining-balance for financial and income tax reporting. (Round your answers for "Net present value" to the nearest whole dollar amount and your answers for "Present value index" to 2 decimal places.) Show less Net present value Present value index b. Reg A and B Req D and EΣ

Answer 1

a.	Depreciation under straight-line method will be same for all years.
	Depreciation expense under straight-line method=(Cost-salvage value)/useful life=(320000-19000)/4=$ 75250
	Annual cash flow:
					$
	Cash revenues				160000
	Less: Depreciation expense				75250
	Income before tax				84750
	Less: Tax at 30%				25425
	Net income				59325
	Add: Depreciation expense				75250
	Annual cash flows				134575
	Discount factor=Desired rate of return=12%
	Net present value:
						$
	Present value of annual cash flows for 4 years
	(134575*3.03735)					408751
	Less: Initial investment					320000
	Net present value					88751
	Present value index=Present value of annual cash flows/Initial investment=408751/320000=1.28
b.	Depreciation rate under double-declining balance method=2*(1/useful life)=2*(1/4)=2*0.25=0.50=50%
	Depreciation rate is applied on the book value of asset
					Year 1	Year 2	Year 3	Year 4
	Beginning book value				320000	160000	80000	40000
	Less: Depreciation at 50%				160000	80000	40000	20000
	Ending book value				160000	80000	40000	20000
	Net present value:
					Year 1	Year 2	Year 3	Year 4
	Cash revenues				150000	150000	150000	150000
	Less: Depreciation expense				160000	80000	40000	20000
	Income before tax				-10000	70000	110000	130000
	Less: Tax at 30%				-4000	28000	44000	52000
	Net income				-6000	42000	66000	78000
	Add: Depreciation expense				150000	150000	150000	150000
	Annual cash flows			a	144000	192000	216000	228000
	Discount factor at 12%			b	0.89286	0.79719	0.71178	0.63552
	Present value of annual cash flows			c=a*b	128571	153061	153745	144898
	Total of c				580275
	Less:Initial investment				320000
	Net present value				260275
	Present value index=Present value of annual cash flows/Initial investment=582075/320000=1.82
d.	Payback period=Initial investment/Annual cashflows=320000/134575=2.38 years
	Unadjusted rate of return=Net income/Average investment
	Average investment=(Beginning book value of investment+Ending book value of investment)/2
	Ending book value under-straight line method=Salvage value=$ 19000
	Average investment=(320000+19000)/2=$ 169500
	Unadjusted rate of return=59325/169500=0.35=35%
e.	Payback period=Initial investment/Average annual cashflow
	Average annual cashflow=Total present value of annual cashflows/Useful life=580275/4=$ 145069
	Payback period=320000/145069=2.21 years
	Unadjusted rate of return=Average annual income/Average investment
	Average annual income=Total net income/useful life=(-6000+42000+66000+78000)/4=$ 45000
	Average investment=(Beginning book value of investment+Ending book value of investment)/2=(320000+20000)/2=$ 170000
	Unadjusted rate of return=45000/170000=0.2647=26.47%