Question

Additional PB ARR Additional Exercise CK Company would like to purchase the molding machine. It has two altematives MC0 and MC009. Both machines have equal useful life, 7 years. The infomation of two machine are as follows MC008 MC009 Initial Cost $440,000 $220,000 Residual Value $20,000 $10,000 Annual Cash Inflow $80,000 $140,000 Annual Cash outflow (exclude repairing, overhaul and tax) $10,000 $40,000 $4,000 year 2 Repairing at the end $12.000 Overhaul at the end of year 3 Assume tax rate is 20% Required: Calculate PB and ARR and identify which model of molding machine should be selected

Answer 1

Answer-1:

Year auw MC008 Net cash inflow Cash inflow Cash outflow Depreciation tax @ 20% before tax 140000 40000 60000 40000 8000 140000 44000 60000 36000 7200 140000 40000 60000 40000 8000 140000 40000 60000 40000 8000 140000 40000 60000 40000 8000 140000 40000 60000 40000 8000 140000 40000 60000 40000 8000 Net cash inflow Cummulative after tax cashflow 92000 92000 888001 180800 92000 272800 92000 364800 92000 456800 92000 548800 92000 640800

Investment = $440,000 - $20,000(residual value) = $420,000

Payback period (MC008) = 4 + ($420,000 - $364,800) / $92,000 = 4 + 0.06 = 4.06 years

Year 1 2 MC009 Net cash inflow Cash inflow Cash outflow Depreciation tax @ 20% before tax 80000 10000 30000 40000 8000 80000 10000 30000 40000 8000 80000 22000 30000 28000 5600 80000 10000 30000 40000 8000 80000 10000 30000 40000 8000 80000 10000 30000 40000 8000 80000 10000 30000 40000 8000 Net cash inflow after tax 62000 62000 52400 62000 62000 62000 62000 cummulative cashflow 62000 124000 176400 238400 3004001 362400 424400

Investment = $220,000 - $10,000(residual value) = $210,000

Payback period (MC009) = 3 + ($210,000 - $176,400) / $62,000 = 3 + 0.54 = 3.54 years

Decision: Molding machine 'MC009' should be selected based on payback period as it is having shorter payback period as compared to 'MC008'.

Answer-2

ARR = Average annual profit / Average investment × 100

MC008:

Average annual profit = $640,800 / 7 = $91,543

Average investment = 1/2 (Initial investment -Salvage value) + Salvage value

                                = 1/2 ($440,000 - $20,000) + $20,000

                                = $230,000

ARR(MC008) = Average annual profit / Average investment × 100

                      = $91,543 / $230,000 × 100 = 39.80%

MC009:

Average annual profit = $424,400 / 7 = $60,629

Average investment = 1/2 (Initial investment -Salvage value) + Salvage value

                                = 1/2 ($220,000 - $10,000) + $10,000

                                = $115,000

ARR(MC008) = Average annual profit / Average investment × 100

                      = $60,629 / $115,000 × 100 = 52.72%

Decision: Molding machine 'MC009' should be selected based on ARR as it is having higher ARR as compared to 'MC008'.