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 $487,000 cost with an expected four-year life and a $23,000 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	$	1,920,000
Expected annual costs of new product
Direct materials		480,000
Direct labor		679,000
Overhead (excluding straight-line depreciation on new machine)		337,000
Selling and administrative expenses		141,000
Income taxes		32	%

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 7% 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.

Please give explinations and formulas!

Answer 1

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1. Compute straight-line depreciation for each year of this new machine’s life.
	Cost of New Machine		487000
	Less: Salvage Value		-23000
	Depreciable Value		464000
	Life		4
	Annual Depreciation		116000
2. Determine expected net income and net cash flow for each year of this machine’s life.
	Expected annual sales of new product	$	1,920,000
	Less:
	Direct materials		480,000
	Direct labor		679,000
	Overhead (excluding straight-line depreciation on new machine)		337,000
	Depreciation		116,000
	Selling and administrative expenses		141,000
	Income Before Tax		167,000
	Less: Tax 32%		53440
	Net Income		113,560
	Cash Flow:
	Net Income		113560
	Add: Non Cash Expense: Depreciation		116,000
	Net Cash Flow		229560
3. Compute this machine’s payback period,
	Cost of Machine/Annual Net Cash flow
	487000/229560
	2.12	Year
4. Compute this machine’s accounting rate of return,
	Net Income/Cost of Machine
	113560/487000
	23.32%
5. Compute the net present value
		Period	PV @ 7%	Amount	PV of Amount
	Initial Investment	0	1	-487000	-487000
	Annual Cash inflow	1-4	3.387211	229560	777568
	Salvage Value	4	0.762895	23000	17547
	NPV				308115