Question

Assessment 9: Making the Right Decision Worksheet
Problems 1–4
																		Input values
Complete problems 1–4 based on the following scenario.
Megacorp needs to decide which of two new projects to invest in.																		Company name				Megacorp
·	Project A is an investment in new machinery that will cost $750,000																	Tax rate				30%
	and has a four-year life with no salvage value.																	Discount rate				6%
·	Project B is an investment in new machinery that will cost $750,000																				Project A	Project B
	and has a three-year life with no salvage value.																	Investment			$ 750,000	$    750,000
Using straight-line depreciation, Megacorp predicts that the two projects																		Life of machinery (in years)			4	3
will yield the following annual results, with cash flows occurring evenly																					four	three
throughout the year.																		Salvage value			$0	$0
Predicted Annual Results																		Predicted Annual Results
						Project A ($)					Project B ($)											Project A ($)	Project B ($)
Sales									700,000					560,000				Sales				700,000	560,000
Expenses:		Direct materials					98,000					70,000						Expenses:	Direct materials			98,000	70,000
		Direct labor					140,000					84,000							Direct labor			140,000	84,000
		Overhead including depreciation					252,000					252,000							Overhead including depreciation			252,000	252,000
		Selling and administrative expenses					50,000					50,000							Selling and administrative expenses			50,000	50,000
		Total expenses							540,000					456,000					Total expenses			540,000	456,000
Pretax income									160,000					104,000				Pretax income				160,000	104,000
Income taxes (30%)									48,000					31,200				Income taxes (30%)				48,000	31,200
Net income									112,000					72,800				Net income				112,000	72,800
Complete the problems below. Add answers in this template and show your work.																		Present value of $1 at 6% annuity for 4 years				3.4651
																		Present value of $1 at 6% annuity for 3 years				2.6730
Problem 1	Compute the annual expected net cash flows for each project.
Problem 2	Determine the payback period for each project.
Problem 3	Compute the accounting rate of return for each project.
Problem 4	Determine the net present value using 6% as the discount rate

Answer 1

1. Calculation of annual expected net cash flows for each project

Deperciation of Poject A = 750000/4 = 187500

Deperciation of Poject B = 750000/3 = 250000

	Project A	Project B
i. Sales	700000	5600000
ii. Less : Expenses	-540000	-456000
iii. Pre dep & tax income (i-ii)	160000	104000
iv. Less : Deperciation	-187500	-250000
v. Pretax income (iii-iv)	-27500	-146000
vi. Less : Tax @ 30%	0	0
vii. Post tax income	-27500	-146000
viii. Add : Deperciation	187500	250000
ix. Annual Cash Flow	160000	104000

2. Calculation of Payback Period

Pay back Period = Initial Investment/Cash Inflow

Project A = 750000/160000 = 4.7 years

Project B = 750000/104000 = 7.2 years

3. Calculation of Accounting Rate of Return

Accounting Rate of Return = Average Accounting Profit/Average Investment

Average Accounting Income of Project A = 160000-187500 = -27500

Average Accounting Income of Project B = 104000-250000 = -146000

ARR of Project A = 27500/750000 = -3.67%

ARR of Project B = 146000/750000 = -19.47%

4. Calculation of NPV

Project A

Years	Cash Flow	Discount factor @6%	Present value
0	-750000	1	-750000
1-4	160000	3.465	554417
		Net Present Value	-195583

Project B

Years	Cash Flow	Discount factor @6%	Present value
0	-750000	1	-750000
1-3	104000	2.673	277993
		Net Present Value	-472007