Question

Exercise 12-6 Simple Rate of Return Method [LO12-6]

The management of Ballard MicroBrew is considering the purchase of an automated bottling machine for $55,000. The machine would replace an old piece of equipment that costs $15,000 per year to operate. The new machine would cost $7,000 per year to operate. The old machine currently in use could be sold now for a salvage value of $26,000. The new machine would have a useful life of 10 years with no salvage value.

Required:

1. What is the annual depreciation expense associated with the new bottling machine?

2. What is the annual incremental net operating income provided by the new bottling machine?

3. What is the amount of the initial investment associated with this project that should be used for calculating the simple rate of return?

4. What is the simple rate of return on the new bottling machine? (Round your answer to 1 decimal place i.e. 0.123 should be considered as 12.3%.)

1. Depreciation expense 2. Incremental net operating income 3 Initial investment 4. Simple rate of return % Exercise 12-7 Net Present Value Analysis of Two Alternatives [LO12-2] Perit Industries has $130,000 to invest. The company is trying to decide between two alternative uses of the funds. The alternatives are: Project A Project B Cost of equipment required $ 130,000 $ 0 Working capital investment required $ 0 $ 130,000 Annual cash inflows $ 21,000 $ 65,000 Salvage value of equipment in six years $ 8,100 $ 0 Life of the project 6 years 6 years The working capital needed for project B will be released at the end of six years for investment elsewhere. Perit Industries’ discount rate is 17%. Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables. Required: 1. Compute the net present value of Project A. (Enter negative value with a minus sign. Round your final answer to the nearest whole dollar amount.) 2. Compute the net present value of Project B. (Enter negative value with a minus sign. Round your final answer to the nearest whole dollar amount.) 3. Which investment alternative (if either) would you recommend that the company accept? 1. Net present value project A 2. Net present value project B 3. Which investment alternative (if either) would you recommend that the company accept?

Answer 1

12-6
1	Annual depreciation expense associated with the new bottling machine
	$55,000/10 = $5,500
2	Annual incremental net operating income provided by the new bottling machine
	Operating cost of old machine	$15,000
	Less: Operating cost of new machine	-$7,000
	Less: Annual depreciation on the new machine	-$5,500
	Annual incremental net operating income	$2,500
3	The amount of the initial investment associated with this projec
	Cost of the new machine	$55,000
	Less: Scrap value of old machine	$26,000
	Initial investment	$29,000
4	The simple rate of return on the new bottling machine
	Simple rate of return = Annual incremental net operating income/Initial investment
	$2,500/$29,000 = 0.0862 i.e. 8.62%
12-7
1	Project -A
	Item	Years	Amount of Cash Inflows	17% Factor	Pvof Cash Flows
	Cost of the equipment	Now	-$130,000	1.000	-$130,000
	Annual cash inflows	1-6	$21,000	3.589	$75,369
	Salvage value of the equipment	6	$8,100	0.390	$3,158
	Net present value				-$51,473
2	Project -A
	Item	Years	Amount of Cash Inflows	17% Factor	Pvof Cash Flows
	Cost of the equipment	Now	-$130,000	1.000	-$130,000
	Annual cash inflows	1-6	$65,000	3.589	$233,285
	Salvage value of the equipment	6	$0	0.390	$0
	Net present value				$103,285
3	Project B