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 $15,000 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	$	1,990,000
Expected annual costs of new product
Direct materials		500,000
Direct labor		675,000
Overhead (excluding straight-line depreciation on new machine)		336,000
Selling and administrative expenses		151,000
Income taxes		30	%

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 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.) Please show how to solve PV Value.

Answer 1

Requirement-1

Straight line method

depreciation    = cost price - salvage value / useful life

= 499,000 - 15,000 / 4

= 484,000 / 4

= 121,000(each year)

Requirement-2

sale of new product	1,990,000
less: cost of new product
direct material	500,000
direct labor	675,000
overhead (excluding depreciation)	336,000
selling and administrative expense	151,000
earnings before tax	328,000
Less: tax (30%)	98,400
net income	229,600

year	net income (1)	Depreciation (2)	cash flow (1+2)
1	229,600	121,000	350,600
2	229,600	121,000	350,600
3	229,600	121,000	350,600
4	229,600	121,000	350,600
	918,400		1,402,400

Requirement-3

Payback period = initial investment / net cash flow

= 499,000 / 350,600

= 1.42 years

Requirement-4

Accounting rate of return = Average annual net income / Average Investment

= 229,600/ 257,000

= 0.8933 x 100 = 89.33%

Average annual net profit = total net profit / useful life

= 918,400/ 4

= 229,600

Average investment = Initial Investment + salvage value / 2

= 499,000 + 15,000 / 2

= 257,000