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 $499,000 cost with an expected four-year life and a $11,000 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	$	1,920,000
Expected annual costs of new product
Direct materials		495,000
Direct labor		674,000
Overhead (excluding straight-line depreciation on new machine)		338,000
Selling and administrative expenses		171,000
Income taxes		36	%

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.
3. Compute this machine’s payback period, assuming that cash flows occur evenly throughout each year.
4. Compute this machine’s accounting rate of return, assuming that income is earned evenly throughout each year.
5. Compute the net present value for this machine using a discount rate of 7% 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.)

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

Compute the net present value for this machine using a discount rate of 7% 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.) (Do not round intermediate calculations. Amounts to be deducted should be indicated by a minus sign.)

	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

Straight Line Depreciation for each year = [Cost of the machine – Salvage Value] / Useful life

= [$499,000 - $11,000] / 4 Years

= $488,000 / 4 Years

= $122,000 per year

2.Expected Net Income and Net cash Flow

EXPECTED NET INCOME		Amount ($)
Revenues
Sales		1,920,000
Expenses
Direct Materials	(495,000)
Direct Labor	(674,000)
Overhead	(338,000)
Straight Line Depreciation	(122,000)
Selling and administrative	(171,000)	(1,800,000)
Income Before Taxes		120,000
Income Tax Expense at 36%		(43,200)
Net Income		76,800
EXPECTED CASH FLOW
Net Income		76,800
Add: Straight Line Depreciation		1,22,000
Expected Cash Flow		198,800

3.Payback Period

Payback Period
Numerator	/	Denominator	=	Payback Period
Initial Investment	/	Annual Net Cash Flow	=	Payback Period
$499,000	/	$198,800	=	2.51 Years

4.Accounting Rate of return

Accounting Rate of return
Numerator	/	Denominator	=	Accounting Rate of return
Net Income	/	Annual average Investment	=	Accounting Rate of return
$76,800	/	$255,000	=	30.12%

Annual average Investment = [Initial Investment + Salvage Value] / 2

= [$599,000 + $11,000] / 2

= $510,000 / 2

= $255,000

Requirement 5 –Net Present Value

Chart values are based on
	n =	4 Years
	i =	7.00%
Cash flow	Select chart	Amount	PV Factor	Present Value
Annual cash flow	Present value of annuity of $1	198,800	3.3872	673,375.36
Residual Value	Present Value of $1	11,000	0.7629	8,391.90
	Present Value of cash inflows			681,767.26
	Present Value of cash outflows			499,000.00
	Net Present Value			182,767.26

NOTE

-The formula for calculating the Present Value Annuity Inflow Factor (PVIFA) is [{1 - (1 / (1 + r)n} / r], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.

-The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)n], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.