Question

Alternate Exercise A Diane Manufacturing Company is considering investing $500,000 in new equipment with an estimated useful life of 10 years and no salvage value. The equipment is expected to produce $320,000 in cash inflows and $200,000 in cash outflows annually. The company uses straight-line depreciation, and has a 30% tax rate.

a. Determine the annual estimated net income and net cash inflow.

b. Calculate the payback period

c. Calculate the accounting rate of return.

Answer 1

(a)-Annual estimated net income and net cash inflow

Income Statement
Cash Inflows	3,20,000
Less: Cash outflows	2,00,000
Less: Depreciation Expenses [$500,000 / 10 Years]	50,000
Earnings Before Tax	70,000
Less: Tax at 30%	21,000
Net Income	49,000

Annual estimated net income = $49,000

Net Cash Inflow = Estimated net income + Depreciation Expenses

= $49,000 + $50,000

= $99,000

(b)-Payback Period

Payback Period = Initial Investment Cost / Annual net cash inflow

= $500,000 / $99,000 per year

= 5.05 Years

(c)-Accounting rate of return

Average Investment = [Cost of the equipment + Salvage value] / 2

= [$500,000 + $0] / 2

= $500,000 / 2

= $250,000

Therefore, the Accounting rate of return = [Annual net income / Average Investment] x 100

= [$49,000 / $250,000] x 100

= 19.60%