Question
In: Accounting
Premiere Company is considering the purchase of a machine to further automate its production line. The...
Premiere Company is considering the purchase of a machine to further automate its production line. The machine will cost P600,000 and has a useful life of 5 years. The straight line method of depreciation is used. Premiere expects annual income before depreciation and taxes of P220,000. Premiere’s income tax rate is 25% and its cost of capital is 16%.
Required:
Determine whether the new machine investment should be accepted using the following: (30 pts)
- Accounting Rate of Return
- Payback Period
- Net Present Value
- Internal Rate of Return
WITH SOLUTION THANK YOU!
Solutions
Expert Solution
| 1 | Accounting rate of return(ARR) | |||||
| =Average Profit/ Average Investment | ||||||
| =$75,000/ $600,000= 12.50% p.a. | ||||||
| Calculation of Depreciation | ||||||
| Depreciation= (Cost-Salvage Value)/Useful life | ||||||
| Cost | a | $ 6,00,000.00 | ||||
| Salvage Value | b | $ - | ||||
| Useful Life(Years) | c | 5 | ||||
| Depreciation | d=(a-b)/c | $ 1,20,000.00 | ||||
| Income before depreciation and taxes | $ 2,20,000.00 | |||||
| Less: Depreciation | $ 1,20,000.00 | |||||
| PBT | $ 1,00,000.00 | |||||
| Less: Tax | $ 25,000.00 | |||||
| PAT | $ 75,000.00 | |||||
| Less: Depreciation | $ 1,20,000.00 | |||||
| Annual Cashflow | $ 1,95,000.00 | |||||
| ARR | 12.50% | |||||
| 2 | Analysis of Payback Period | |||||
| Year | Net Cashflow | Cumulative Cashflow | ||||
| 0 | $ (6,00,000) | $ (6,00,000) | ||||
| 1 | $ 1,95,000 | $ (4,05,000) | ||||
| 2 | $ 1,95,000 | $ (2,10,000) | ||||
| 3 | $ 1,95,000 | $ (15,000) | ||||
| 4 | $ 1,95,000 | $ 1,80,000 | ||||
| 5 | $ 1,95,000 | $ 3,75,000 | ||||
| Payback Period | 3.08 years | |||||
| Payback Period = 3 years + $15,000/$195,000 years | ||||||
| =3 years + 0.08 years | ||||||
| = 3.08 years | ||||||
| 3 | Analysis of Net present value | |||||
| Particulars | Year | Cashflow |
Present value @16% p.a. |
Net Present Value | ||
| Cost of new equipment | 0 | $ (6,00,000) | 1.0000 | $ (6,00,000) | ||
| Annual cash inflow | 1 | $ 1,95,000 | 0.862 | $ 1,68,103 | ||
| Annual cash inflow | 2 | $ 1,95,000 | 0.743 | $ 1,44,917 | ||
| Annual cash inflow | 3 | $ 1,95,000 | 0.641 | $ 1,24,928 | ||
| Annual cash inflow | 4 | $ 1,95,000 | 0.552 | $ 1,07,697 | ||
| Annual cash inflow | 5 | $ 1,95,000 | 0.476 | $ 92,842 | ||
| Net present value | $ 38,487 | |||||
| 4 | Internal rate of return(IRR) | |||||
| Particulars | Year | Cashflow | ||||
| Cost of new equipment | 0 | $ (6,00,000) | ||||
| Annual cash inflow | 1 | $ 1,95,000 | ||||
| Annual cash inflow | 2 | $ 1,95,000 | ||||
| Annual cash inflow |
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