Question

Most Company has an opportunity to invest in one of two new projects. Project Y requires a $330,000 investment for new machinery with a five-year life and no salvage value. Project Z requires a $330,000 investment for new machinery with a four-year life and no salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation, and cash flows occur evenly throughout each year. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

	Project Y				Project Z
Sales		$	365,000			$	292,000
Expenses
Direct materials			51,100				36,500
Direct labor			73,000				43,800
Overhead including depreciation			131,400				131,400
Selling and administrative expenses			26,000				26,000
Total expenses			281,500				237,700
Pretax income			83,500				54,300
Income taxes (38%)			31,730				20,634
Net income		$	51,770			$	33,666

4. Determine each project’s net present value using 7% as the discount rate. Assume that cash flows occur at each year-end. (Round your intermediate calculations.)

	Project Y Chart values are based on: n = i = Select Chart Amount x PV Factor = Present Value = Net present value Project Z Chart values are based on: n = i = Select Chart Amount x PV Factor = Present Value = Net present value

Answer 1

FOR PROJECT Y

Depreciation is a non cash, non operating expense, therefore first it is included to calculate net income for tax benefits and then added back to the net income to calculate annual cash flow.

Annual cash flow (after tax before depreciation) = net income + depreciation

Annual depreciation by straight line method = (initial cost - salvage value)/useful life

= ($330000 - 0)/5 = $66000

Therefore,

Annual cash flow = $51770 + $66000 = $117770

For $1, PVAF (7%, 5) = 4.100

Therefore,

Present value of annual cash flow $117770 = $117770 x 4.100

= $482857

Net present value = present value of annual cash flow - initial investment

= $482857 - $330000

= $152857

PROJECT Z

Annual cash flow (after tax before depreciation) = net income + depreciation

Depreciation = ($330000 - 0)/4

= $82500

Therefore,

Annual cash flow = $33666 + $82500 = $116166

For $1, PVAF (7%, 4) = 3.387

Therefore,

Present value of annual cash flow = $116166 x 3.387 = $393454

Therefore,

Net present value = $393454 - $330000

= $63454