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 $820,000 cost with an expected four-year life and a $54,000 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 $ 2,690,000 Expected annual costs of new product Direct materials 514,000 Direct labor 706,000 Overhead (excluding straight-line depreciation on new machine) 676,000 Selling and administrative expenses 194,000 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

1.

Annual depreciation = (Purchase price – Salvage value)/Number of useful years

                                    = ($ 820,000 - $ 54,000)/4

                                    = $ 766,000/4 = $ 191,500

2.

Revenue
Expected annual sales of new products		$ 2,690,000
Less: Expenses
Direct material	$ 514,000
Direct labor	$ 706,000
Overhead	$ 676,000
Selling and administrative expenses	$ 194,000
Total expenses		$ 2,090,000
PBDT		$ 600,000
Less: Depreciation		$ 191,500
BPT		$ 408,500
Less: Tax @ 30 %		$ 122,550
Net income		$ 285,950
Add: Depreciation		$ 191,500
Net annual cash flow		$ 477,450

  3.

Pay back period = Initial investment/Annual cash flow

                         = $ 820,000/$ 477,450 = 1.717457325 or 1.72 years

4.

Accounting rate of return = Net annual income/Net investment

                                        = $ 285,950/ ($ 820,000 - $ 54,000)

                                        = $ 285,950/$ 766,000 = 0.373302872 or 37.33%

5.

	Chart Values are Based on
	n=	4
	i=	4%
Cash Flow	Select Chart	Amount	x	PV Factor	=	Present Value
Annual Cash Flow	Present Value of an Annuity of 1	$477,450	x	3.6299	=	$1,733,095.755
Residual Value	Present Value of 1	$54,000	x	0.8548	=	$46,159.20
	Present Value of Cash Inflow		$1,779,254.955
	Present Value of Cash Out Flow		-$820,000
	Net Present Value		$959,254.955