Question

13. A

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 $511,000 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	$	1,950,000
Expected annual costs of new product
Direct materials		490,000
Direct labor		673,000
Overhead (excluding straight-line depreciation on new machine)		337,000
Selling and administrative expenses		141,000
Income taxes		38	%

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.)

	Straight-line depreciation.

	Payback Period Choose Numerator: / Choose Denominator: = Payback Period / = Payback period =

Answer 1

Answer:

1. Straight-line depreciation for each year of this new machine’s life

Depreciation under Straight-line method

= [(Cost of the asset - Estimated salvage value) / Expected useful life of the asset]

= [($511,000 - $11,000) / 4]

= $500,000 / 4

= $125,000

2. Expected net income and net cash flow for each year of this machine’s life

3. Payback period, assuming that cash flows occur evenly throughout each year

Payback period = Initial investment / Net annual cash inflows

                             = $511,000 / $239,080

                             = 2.13 years

4. Accounting rate of return, assuming that cash flows occur evenly throughout each year

Accounting rate of return = Average Net income / Average investment

                                             = $114,080 / $511,000

                                             = 0.2232   or 22.32%

5. Net Present value using 6% as discount rate

Net Present value = Present value of total cash inflows - Present value of total cash outflows

Present value of total cash outflows

Present value of total cash outflows = $511,000

Present value of total cash inflows

Net Present value = Present value of total cash inflows - Present value of total cash outflows

                                 = $837,124.2 - $511,000

                                = $326,124.2