Question

Most Company has an opportunity to invest in one of two new projects. Project Y requires a $340,000 investment for new machinery with a five-year life and no salvage value. Project Z requires a $340,000 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		$	380,000			$	304,000
Expenses
Direct materials			53,200				38,000
Direct labor			76,000				45,600
Overhead including depreciation			136,800				136,800
Selling and administrative expenses			27,000				27,000
Total expenses			293,000				247,400
Pretax income			87,000				56,600
Income taxes (36%)			31,320				20,376
Net income		$	55,680			$	36,224

A. Compute each project’s annual expected net cash flows.

B. Determine each project’s payback period.

C. Compute each project’s accounting rate of return.

D. Determine each project’s net present value using 6% as the discount rate. Assume that cash flows occur at each year-end. (Round your intermediate calculations.)

Answer 1

Project Y

a) Depreciation of machinery every year = 340000/5 = $68000 p.a

Overhead exp excluding depreciation = 136800 - 68000 = $68800

Therefore net profit in cash = 55680+ 68000 = $123680

Annual expected cash flow = $123680

b) Payback period = 340000/123680 = 2 years 9 months

c) Rate of return = 123680/340000 = 36.37%

d) NPV = cash flow for 1st year = 123680/1.06 = $116680

cash flow for 2nd year = 123680/(1.06)^2 = $110075

cash flow for 3rd year = 123680/(1.06)^3 = $103844

  cash flow for 4th year = 123680/(1.06)^4 = $ 97966

  cash flow for 5th year = 123680/(1.06)^5 = $ 92421

Total Cash Flow = $520986

NPV = $520986 - $340000 = $180986

Project Z

a) Depreciation of machinery every year = 340000/4 = $85000 p.a

Overhead exp excluding depreciation = 136800 - 85000 = $51800

Therefore net profit in cash = 55680+ 85000 = $140680

Annual expected cash flow = $140680

b) Payback period = 340000/140680 = 2 years 5 months

c) Rate of return = 140680/340000 = 41.38%

d) NPV = cash flow for 1st year = 140680/1.06 = $132717

cash flow for 2nd year = 140680/(1.06)^2 = $125205

cash flow for 3rd year = 140680/(1.06)^3 = $118118

  cash flow for 4th year = 140680/(1.06)^4 = $ 111432

Total Cash Flow = $487472

NPV = $487472 - $340000 = $147472