Question

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)

1. Accounting Rate of Return
2. Payback Period
3. Net Present Value
4. Internal Rate of Return

WITH SOLUTION THANK YOU!

Answer 1

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
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