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 $491,000 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	$	1,910,000
Expected annual costs of new product
Direct materials		475,000
Direct labor		675,000
Overhead (excluding straight-line depreciation on new machine)		336,000
Selling and administrative expenses		167,000
Income taxes		34	%

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.)

1.

Straight-Line Depreciation

2.

Expected Net Income
Revenues
Expenses
Expected Net Cash Flow

3. Payback Period

Choose Numerator	/	Choose Denominator	=	Payback Period
	/		=	Payback Period
	/		=

4. Accounting Rate of Return

Choose Numerator	/	Choose Denominator	=	Accounting Rate of Return
	/		=
	/		=

5.

	Chart Values are Based on:
	n=
	i=
Cash Flow	Select Chart	Amount	x	PV Factor	=	Present Value
Annual Cash Flow					=
Residual Value					=
	Net Present Value

Answer 1

1. Straight Line Depreciation :

Depreciation = (Cost of the asset - Salvage value) / Expected useful life

Depreciation = (491000 - 15000) / 4 = 119000

Straight line depreciation for each year of new machine's life = $119000

2. Expected Net Income and Expected Net Cash flow:

Particulars	Amount in $
Expected annual sales of new product	1910000
Less: Expected annual costs of new product :
Direct materials	475000
Direct labor	675000
Overhead (excluding straight-line depreciation on new machine)	336000
Selling and administrative expenses	167000
Income before taxes and depreciation	257000
(-) Depreciation	119000
Income before taxes	138000
(-) Income tax expense (34%)	46920
Expected Net Income	91080

Expected Net Income	91080
(+) Depreciation	119000
Expected Net Cash flow	210080

3. Payback period:

Payback period = Initial Investment / Cash Inflow per period

Payback period = 491000 / 210080 = 2.34 years

Therefore payback period = 2 years 4 months

4. Accounting Rate of Return :

ARR = Net Income / Initial Investment

ARR = 91080 / 491000 = 18.549%

Therefore accounting rate of return is 18.55%

5. Net Present Value:

Particulars		PVAF ( 6% , 4 yrs)	Present Value
Net cash inflow	210080	3.4651	727949.208	A
Salvage value	15000	3.4651	51976.5	B
Present value of cash inflows (A+B)			779925.708
Less: Cost of investment(cash outflow)			491000
Net present value			288925.708

Therefore NPV is $288925.71