Question

Factor Company is planning to add a new product to its line. To manufacture this product, the company needs to buy a new machine at a $519,000 cost with an expected four-year life and a $23,000 salvage value. All sales are for cash, and all costs are out-of-pocket, except for depreciation on the new machine. Additional information includes the following. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

Expected annual sales of new product	$	1,940,000
Expected annual costs of new product
Direct materials		500,000
Direct labor		680,000
Overhead (excluding straight-line depreciation on new machine)		338,000
Selling and administrative expenses		166,000
Income taxes		40	%

Required:
1. Compute straight-line depreciation for each year of this new machine’s life.
2. Determine expected net income and net cash flow for each year of this machine’s life.

	Expected Net Income Revenues Expenses Expected Net Cash Flow

3. Compute this machine’s payback period, assuming that cash flows occur evenly throughout each year.

	Payback Period Choose Numerator: / Choose Denominator: = Payback Period / = Payback period =

4. Compute this machine’s accounting rate of return, assuming that income is earned evenly throughout each year.

	Accounting Rate of Return Choose Numerator: / Choose Denominator: = Accounting Rate of Return / = Accounting rate of return

5. Compute the net present value for this machine using a discount rate of 6% and assuming that cash flows occur at each year-end. (Hint: Salvage value is a cash inflow at the end of the asset’s life.)

Chart Values are Based on: n = i = % Cash Flow Select Chart Amount x PV Factor = Present Value Annual cash flow = Residual value = Net present value

Answer 1

1.)	Straight line depreciation each year	$ 124,000	( 519,000 - 23,000 ) /4
2.)		Amount in $
	Expected annual sales of new product	1,940,000
	Less :Expected annual costs of new product
	Direct materials	500,000
	Direct labor	680,000
	Overhead (excluding straight-line depreciation on new machine)	338,000
	Selling and administrative expenses	166,000
	Depreciation	124,000
	Earnings before tax	132,000
	Less: Tax @40%	52,800
	Expected Net Income	79,200
	Expected Net cash flow	$ 203,200	( 79,200 + 124,000 )

3.)	Payback period
	Cost of machine	/	Expected Net cash flow	=	Payback period
	519,000	/	203,200	=	2.55 Years
4.)	Accounting rate of return
	Expected Net Income	/	Average Investment	=	Accounting rate of return
	79,200	/	271,000	=	29.23%
	Average Investment	$ 271,000
	( 519,000 + 23,000 ) /2

5.)	n=	4
	i=	6%
						Amount in $
	Annual Cash flow	203,200	x	3.46511	=	704,110
	Residual Value	23,000	x	0.79209	=	18,218
						722,328
	Less: Cost of Machine					519,000
	Net Present Value					203,328