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 $620,000 cost with an expected four-year life and a $34,000 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. Round PV factor value to 4 decimal places.)

Expected annual sales of new product	$	2,190,000
Expected annual costs of new product
Direct materials		494,000
Direct labor		686,000
Overhead (excluding straight-line depreciation on new machine)		476,000
Selling and administrative expenses		174,000
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 4% 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.)

Answer 1

Answer 1.

Initial Investment = $620,000
Salvage Value = $34,000
Useful Life = 4 years

Annual Depreciation = (Initial Investment - Salvage Value) / Useful Life
Annual Depreciation = ($620,000 - $34,000) / 4
Annual Depreciation = $146,500

Answer 2.

Answer 3.

Payback Period = Cost of Investment / Annual Net Cash Flow
Payback Period = $620,000 / $295,950
Payback Period = 2.09 years

Answer 4.

Annual Average Investment = (Initial Investment + Salvage Value) / 2
Annual Average Investment = ($620,000 + $34,000) / 2
Annual Average Investment = $327,000

Accounting Rate of Return = Annual Net Income / Annual Average Investment
Accounting Rate of Return = $149,450 / $327,000
Accounting Rate of Return = 45.70%

Answer 5.