Question

Campbell Electronics is considering investing in manufacturing equipment expected to cost $240,000. The equipment has an estimated useful life of four years and a salvage value of $ 18,000. It is expected to produce incremental cash revenues of $120,000 per year. Campbell has an effective income tax rate of 35 percent and a desired rate of return of 14 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

   

Required

Determine the net present value and the present value index of the investment, assuming that Campbell uses straight-line depreciation for financial and income tax reporting.

Determine the net present value and the present value index of the investment, assuming that Campbell uses double-declining-balance depreciation for financial and income tax reporting.

Determine the payback period and unadjusted rate of return (use average investment), assuming that Campbell uses straight-line depreciation.

Determine the payback period and unadjusted rate of return (use average investment), assuming that Campbell uses double-declining-balance depreciation. (Note: Use average annual cash flow when computing the payback period and average annual income when determining the unadjusted rate of return.)

** use all decimal factors

Answer 1

Solution 1:

Computation of Annual cash flows - SLM
Particulars	Amount
Incremental cash revenues	$120,000.00
Annual depreciation	$55,500.00
Incremental income	$64,500.00
Tax (35%)	$22,575.00
Income after tax	$41,925.00
Add: Depreciation	$55,500.00
Annual after tax cash flows	$97,425.00

Computation of NPV and Present Value Index - Campbell (SLM)
Particulars	Amount	Period	PV Factor	Present Value
Cash Outflows:
Cost of Investment	$240,000	0	1	$240,000
Present Value of Cash Outflows (A)				$240,000
Cash Inflows:
Annual cash inflows	$97,425	1-4	2.91371	$283,868
Salvage Value	$18,000	4	0.59208	$10,657
Present Value of Cash Inflows (B)				$294,526
Net Present Value (B-A)				$54,526
Present Value Index (B/A)				1.23

Solution 2:

Depreciation Schedule - Double Declining Method
Year	Depreciation Expense	Accumulated Depreciation	Net Book Value
Acquisition Cost			$240,000.00
1	$120,000.00	$120,000.00	$120,000.00
2	$60,000.00	$180,000.00	$60,000.00
3	$30,000.00	$210,000.00	$30,000.00
4	$12,000.00	$222,000.00	$18,000.00

Computation of Annual after tax Cash Flows - DDB
Particulars	Year 1	Year 2	Year 3	Year 4
Incremental cash revenues	$120,000.00	$120,000.00	$120,000.00	$120,000.00
Less: Depreciation Expense	$120,000.00	$60,000.00	$30,000.00	$12,000.00
Income before taxes	$0.00	$60,000.00	$90,000.00	$108,000.00
Income Tax (35%)	$0.00	$21,000.00	$31,500.00	$37,800.00
Income after taxes	$0.00	$39,000.00	$58,500.00	$70,200.00
Add: Depreciation	$120,000.00	$60,000.00	$30,000.00	$12,000.00
After tax cash flows	$120,000.00	$99,000.00	$88,500.00	$82,200.00

Computation of NPV and present value index - Campbell (DDB)
Particulars	Period	PV Factor	Amount	Present Value
Cash outflows:
Cost of Investment	0	1	$240,000	$240,000
Present Value of Cash outflows (A)				$240,000
Cash Inflows
Annual increase in Cash Inflows:
Year 1	1	0.87719	$120,000	$105,263
Year 2	2	0.76947	$99,000	$76,177
Year 3	3	0.67497	$88,500	$59,735
Year 4	4	0.59208	$82,200	$48,669
Salvage Value	4	0.59208	$18,000	$10,657
Present Value of Cash Inflows (B)				$300,502
Net Present Value (NPV) (B-A)				$60,502
Present Value Index (B/A)				1.25

Solution 3:

Payback period = Initital investment / annual cash inflows = $240,000 / $97,425 = 2.46 years

Unadjusted rate of return = Average annual income / Average investment

Average annual income = $41,925

Average investment = ($240,000 +$18,000)/2 = $129,000

Unadjusted rate of return = $41,925 / $129,000 = 32.5%

Solution 4:

Computation of cumulative cash flows
Year	Cash Flows	Cumulative cash flows
1	$120,000.00	$120,000.00
2	$99,000.00	$219,000.00
3	$88,500.00	$307,500.00
4	$100,200.00	$407,700.00

Payback period = 2 years + ($240,000 - $219,000) / $88,500 = 2.24 years

Unajdusted rate of return = Average annual income / Average investment

Average annual income = ($0 + $39,500 + $58,500 + $70,200)/4 = $41,925

Average investment = ($240,000 +$18,000)/2 = $129,000

Unadjusted rate of return = $41,925 / $129,000 = 32.5%