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