Question

Question 2

Olsen Inc. purchased a $450,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high demand and Olsen can sell all that it could manufacture for the next 10 years. To encourage capital investments, the government exempts taxes on profits from new investments in this type of machinery. This legislation most likely will remain in effect in the foreseeable future. The equipment is expected to have 10 years of useful life and no salvage value at the end of this 10-year period. The firm uses straight-line depreciation. The net cash inflow is expected to be $132,000 each year. Olsen uses a discount rate of 10% in evaluating its capital investments.

The estimated accounting (book) rate of return (to two decimal places) based on average investment for this proposed investment is:

Multiple Choice

• 23.40%.

• 24.67%.

• 36.12%.

• 38.67%.

• 61.57%.

GuSont Inc. was considering an investment in the following project:

Required initial investment	$	920,000
Net annual after-tax cash inflow	$	165,000
Annual depreciation expense (($920,000 − $169,000)/20 years)	$	37,550
Estimated salvage value	$	169,000
Life of the project in years		20

Assume that cash inflows occur evenly throughout the year. The estimated payback period in years (rounded to one decimal place) for the proposed project is:

Multiple Choice

• 3.3 years.

• 4.2 years.

• 5.4 years.

• 5.6 years.

• 7.5 years.

Answer 1

1. 38.67%

Cost	$                       450,000
Salvage	$                                   -
Useful Life	10
Depreciation	$                         45,000
Net Cash Infow	$                       132,000
Net Accounting Profit (Net Cash Infow - Depreciation	$                         87,000
ARR (Net Accounting Profit/(Average cost)	=87,000/(4,50,000/2)
ARR (Net Accounting Profit/(Average cost)	38.67%

2. 5.6 yrs

Required Payback = $9,20,000

Payback till 5 yr = $8,25,000

More required in Yr 6 = $9,20,000 -  $8,25,000 = 95,000

Yr 6 inflow = $ 1,65,000, therefore period for getting $ 95,000 = $ 95,000 / ($ 1,65,000/12) = ~ 6.9 months

Therefore Payback period = 5.6 yrs

Yr	Cash Inflow	Cummulative Cash Inflow
1	$     165,000	$                                  165,000
2	$     165,000	$                                  330,000
3	$     165,000	$                                  495,000
4	$     165,000	$                                  660,000
5	$     165,000	$                                  825,000
6	$     165,000	$                                  990,000