Question

Problem 24-1A Computation of payback period, accounting rate of return, and net present value LO P1, P2, P3 Factor 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 $720,000 cost with an expected four-year life and a $44,000 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) (Use appropriate factor(s) from the tables provided. Round PV factor value to 4 decimal places.)

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. 4. Compute this machine’s accounting rate 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 7% 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.)

Problem 24-1A Computation of payback period, accounting rate of return, and net present value LO P1, P2, P3 Factor 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 $720,000 cost with an expected four-year life and a $44,000 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) (Use appropriate factor(s) from the tables provided. Round PV factor value to 4 decimal places.) $2,440,000 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 504,000 696,000 576,000 184,000 30% 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. 4. Compute this machine's accounting rate 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 7% 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.) Complete this question by entering your answers in the tabs below. Required 1 Required 2 Required 3 Required 4 Required 5 Compute straight-line depreciation for each year of this new machine's life. Straight-line depreciation Required 1 Required 2 >

Answer 1

(1) straight line depreciation = (cost- salvage) / useful life

=($720,000-$44,000)/4 years

=$169,000

(2)

net income and cash flow

in determining net income depreciation will be deducted.

however for cash flow purpose depreciation will be added back as it is non cash expense.

Revenues
sales		$2,440,000
expenses
direct material	$504,000
direct labor	$696,000
overhead	$576,000
selling and administrative expense	$184,000
depreciation	$169,000
Total expense		$2,129,000
income before taxes		$311,000
income tax expense (30%) [311000*30%]		$93,300
net income		$217,700
CASH FLOW
NET INCOME		$217,700
depreciation		$169,000
Net cash flow [217700+169000]		$386,700

(3) payback period is the time period within which initial investment is covered back in form of cash inflow.

numerator	denominator	payback period
cost of investment	annual net cash flow
720,000	$386,700	1.86 years

(4) annual rate of return

numerator	denominator	accounting rate of return
annual after tax net income	annual average investment
$217,700	$382,000	56.99%

average investment = investment at the beginning+ salvage /2

(720000+44000)/2

=$382,000

rate of return = 217,700/382000*100

=56.99%

(5)Net present value is difference between initial cash investment and present value of cash flow

		n = 4
		I = 7%
			PV factor	present value
Annual cash flow	present value of annuity $1	$386,700	3.3872	$1,309,830[386700*3.3872)
residual value	present value of $1	$44000	0.7629	$33,568[44000*0.7629]
			present value of cash inflow	$1,343,398 [1309830+33568]
			present value of cash outflow	$720,000
			Net present value	$623,398 [1,343,398-720,000]