Question

A company is planning to add a new product to its line. To manufacture this product, the company needs to buy a new machine at a $487,000 cost with an expected four-year life and a $23,000 salvage value. All sales are for cash, and all costs are out-of-pocket, except for depreciation on the new machine. Additional information includes the following. (PV of $1, FV of $1, PVA of $1, and FVA of $1).

$1,890,000 Expected annual sales of new product Expected annual costs of new product Direct materials Direct labor Overhead (excluding straight-line depreciation on new machine) Selling and administrative expenses Income taxes 460,000 679,000 336,000 170,000 401 Required: 1. Compute straight-line depreciation for each year of this new machine's life. 2. Determine expected net income and net cash flow for each year of this machine's life. 3. Compute this machine's payback period, assuming that cash flows occur evenly throughout each year. of return, assuming that income is earned evenly throughout each year. 5. Compute the net present value for this machine using a discount rate of 8% and assuming that cash flows occur at each year-end. (Hint: Salvage value is a cash inflow at the end of the asset's life.)

Answer 1

Answer 1.

Initial Investment = $487,000
Salvage Value = $23,000
Useful Life = 4 years

Annual Depreciation = (Initial Investment - Salvage Value) / Useful Life
Annual Depreciation = ($487,000 - $23,000) / 4
Annual Depreciation = $116,000

Answer 2.

$ 1,890,000 $ $ Expected Net Income Revenues Sales Expenses Direct materials Direct labor Overhead excluding depreciation Selling and administrative expenses Depreciation Total expenses Income before taxes Income tax expense Net income Expected Net Cash Flow Net income Depreciation Net cash flow 460,000 679,000 336,000 170,000 116,000 $ $ $ $ $ $ 1,761,000 129,000 51,600 77,400 $ $ $ 77,400 116,000 193,400

Answer 3.

Payback Period = Cost of Investment / Annual Net Cash Flow
Payback Period = $487,000 / $193,400
Payback Period = 2.52 years

Answer 4.

Annual Average Investment = (Initial Investment + Salvage Value) / 2
Annual Average Investment = ($487,000 + $23,000) / 2
Annual Average Investment = $255,000

Accounting Rate of Return = Annual Net Income / Annual Average Investment
Accounting Rate of Return = $77,400 / $255,000
Accounting Rate of Return = 30.35%

Answer 5.

Chart Values are Based on: Cash Flow Annual cash flow Residual value 8.00% Select Chart Amount PVA of $1 $ 193,400.00 PV of $1 $ 23,000.00 Present value of cash inflows Present value of cash outflows Net present value x x x PV Factor = 3.3121] = 0.7350 = = = = Present Value $ 640,560.14 $ 16,905.00 $ 657,465.14 $ 487,000.00 $ 170,465.14