Question

Franklin Electronics is considering investing in manufacturing equipment expected to cost $270,000. The equipment has an estimated useful life of four years and a salvage value of $ 16,000. It is expected to produce incremental cash revenues of $135,000 per year. Franklin has an effective income tax rate of 30 percent and a desired rate of return of 12 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

   

Required

1. Determine the net present value and the present value index of the investment, assuming that Franklin uses straight-line depreciation for financial and income tax reporting.

2. Determine the net present value and the present value index of the investment, assuming that Franklin uses double-declining-balance depreciation for financial and income tax reporting.

4. Determine the payback period and unadjusted rate of return (use average investment), assuming that Franklin uses straight-line depreciation.

5. Determine the payback period and unadjusted rate of return (use average investment), assuming that Franklin uses double-declining-balance depreciation. (Note: Use average annual cash flow when computing the payback period and average annual income when determining the unadjusted rate of return.)

Determine the net present value and the present value index of the investment, assuming that Harper uses straight-line depreciation and double-declining-balance for financial and income tax reporting. (Round your answers for "Net present value" to the nearest whole dollar amount and your answers for "Present value index" to 2 decimal places.)

	Net present value Present value index a. b.

Determine the payback period and unadjusted rate of return (use average investment), assuming that Harper uses straight-line depreciation and double-declining-balance depreciation. (Note: Use average annual cash flow when computing the payback period and average annual income when determining the unadjusted rate of return.) (Round your answers to 2 decimal places.)

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	Payback period Unadjusted rate of return d. years % e. years %

Answer 1

Franklin Electronics
a.	Determine the net present value and the present value index of the investment, assuming that Franklin uses straight-line depreciation for financial and income tax reporting.
Ans.	Straight line method of depreciation	$
	Original cost of equipment	2,70,000
	Salvage value	16,000
	Depreciable amount	2,54,000
	Useful life in years	4
	Depeciation per year = 2,54,000/4	63,500
	Incremental cash revenues per year	1,35,000
	Tax rate	30%
	Desired rate of return	12%
	Calculation of net present value
		Year 0	Year 1	Year 2	Year 3	Year 4
	Original cost of equipment (C)	-2,70,000
	Revenue		1,35,000	1,35,000	1,35,000	1,35,000
	Less : Depreciation (B)		63,500	63,500	63,500	63,500
	Profit before tax		71,500	71,500	71,500	71,500
	Less : Tax at 30%		21,450	21,450	21,450	21,450
	Profit after tax (A)		50,050	50,050	50,050	50,050
	Cash inflow (A) + (B) (D)		1,13,550	1,13,550	1,13,550	1,13,550
	Salvage value of equipment (E)					16,000
	Net cash flow (C) +(D) + (E)	-2,70,000	1,13,550	1,13,550	1,13,550	1,29,550
	Discount factor	1	1.12	1.2544	1.404928	1.57351936
	Present value of cash flow	-2,70,000	1,01,384	90,521	80,823	82,331
	Net present value	85,059
	Present value index = (NPV + Initial investment)/ Initial investment
	(270000+85059)/270000 =	1.32

b.	Determine the net present value and the present value index of the investment, assuming that Franklin uses double-declining-balance depreciation for financial and income tax reporting.
Ans.	Double declining balance method of depreciation
	In this method the depreciation rate will be twice the depreciation rate as per straight line method.
	Since useful life is 4 years, straight line method depreciation rate is 25%
	So double declining method, the rate will be 50%
	The depreciation amount is calculated as shown below :-
	Original cost	2,70,000
	Less : Depreciation 50%	1,35,000
	WDV at end of year 1	1,35,000
	Less : Depreciation 50%	67,500
	WDV at end of year 2	67,500
	Less : Depreciation 50%	33,750
	WDV at end of year 3	33,750
	Less : Depreciation 50%	16,875
	WDV at end of year 4	16,875
	The net present value as per double declining method is calculated as shown below :-
		Year 0	Year 1	Year 2	Year 3	Year 4
	Original cost of equipment (C)	-2,70,000
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