Question

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 $540,000 cost with an expected four-year life and a $26,000 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.)

Expected annual sales of new product	$	1,990,000
Expected annual costs of new product
Direct materials		486,000
Direct labor		678,000
Overhead (excluding straight-line depreciation on new machine)		396,000
Selling and administrative expenses		166,000
Income taxes		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 6% 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

Solution 1:

Straight-line depreciation for each year = ($540,000 - $26,000) / 4 = $128,500

Solution 2:

Expescted Net Income
Revenues:
Sales		$19,90,000
Expenses:
Direct Materials	$4,86,000
Direct Labor	$6,78,000
Overhead excluding depreciation	$3,96,000
Selling and administrative expenses	$1,66,000
Straight line depreciation	$1,28,500
Total Expenses		$18,54,500
Income before taxes		$1,35,500
Income tax expense (30%)		$40,650
Net Income		$94,850
Expected net Cash Flow
Net Income		$94,850
Add: Straight line Depreciation		$1,28,500
Net Cash Flow		$2,23,350

Solution 3:

Payback Period
Choose Numerator	/	Choose Denominator	=	Payback Period
Cost of investment	/	Annual net Cash flow	=	Payback Period
$5,40,000	/	$2,23,350	=	2.42 years

Solution 4:

Accounting rate of Return
Choose Numerator	/	Choose Denominator	=	Accounting Rate of Return
Annual Net Income after tax	/	Average Investment	=	Accounting Rate of Return
$94,850	/	$2,83,000	=	33.52%

Solution 5:

	Chart Values are based on
	n=	4
	i=	6%
Cash Flow	Select Chart	Amount	*	PV Factor	=	Present Value
Annual cash Flow	Present Value of an annuity of 1	$2,23,350	*	3.4651	=	$7,73,930
Residual Value	present value of 1	$26,000	*	0.7921	=	$20,595
	Present value of cash inflows					$7,94,525
	Present value of cash outflows					-$5,40,000
	Net Present Value					$2,54,525