Question

Most Company has an opportunity to invest in one of two new projects. Project Y requires a $320,000 investment for new machinery with a six-year life and no salvage value. Project Z requires a $320,000 investment for new machinery with a five-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. (FV of $1, PV of $1, FVA of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

	Project Y					Project Z
Sales		$	375,000				$	300,000
Expenses
Direct materials			52,500					37,500
Direct labor			75,000					45,000
Overhead including depreciation			135,000					135,000
Selling and administrative expenses			27,000					27,000
Total expenses			289,500					244,500
Pretax income			85,500					55,500
Income taxes (30%)			25,650					16,650
Net income		$	59,850				$	38,850

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

     

Determine each project’s payback period.

     

Compute each project’s accounting rate of return.

     

Answer 1

Answer:

Ans. 1	*First of all we need to calculate the annual depreciation expenses.
	*Depreciation = (Cost of project - Salvage value) / Useful life in years
Project Y	($320,000 - $0) / 6	$53,333
Project Z	($320,000 - $0) / 5	$64,000
		Project Y	Project Z
	Net income	$59850	$38850
	Add: Depreciation	$53,333	$64,000
	Net cash inflow	$113183	$102850
Ans. 2	Payback period = Initial investment / Annual cash inflows
Project Y	$320,000 / $113183	2.83	years
Project Z	$320,000 / $102850	3.11	years
Ans. 3	Accounting rate of return =   Net income / Average investment * 100
Project Y	$59850 / $160,000 * 100	37.41%
Project Z	$38850 / $160,000 * 100	24.28%
	*Average investment =   (Cost of maching + Salvage value) / 2
Project Y	($320,000 + 0) / 2	$160,000
Project Z	($320,000 + 0) / 2	$160,000