Question

Problem 24-2A Analysis and computation of payback period, accounting rate of return, and net present value LO P1, P2, P3

Most Company has an opportunity to invest in one of two new projects. Project Y requires a $305,000 investment for new machinery with a three-year life and no salvage value. Project Z requires a $305,000 investment for new machinery with a two-year life and no salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation, and cash flows occur evenly throughout each year. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)



Project Y Project Z
Sales $ 355,000 $ 345,000
Expenses
Direct materials 49,700 43,125
Direct labor 71,000 51,750
Overhead including depreciation 127,800 155,250
Selling and administrative expenses 25,000 31,000

Total expenses 273,500 281,125

Pretax income 81,500 63,875
Income taxes (36%) 29,340 22,995

Net income $ 52,160 $
40,880

1. Compute each project�s annual expected net cash flows.

Project Y Project Z

2. Determine each project�s payback period

Payback Period

Project Y

Project Z

3. Compute each project�s accounting rate of return.

Project Y

Project Z

4. Determine each project�s net present value using 8% as the discount rate. Assume that cash flows occur at each year-end.

Answer 1

1. Compute each project's annual expected net cash flows. Project Y: $81,500, Project Z: $63,875. 2. Determine each project's payback period. Project Y: 3.74 years, Project Z: 4.78 years. 3. Compute each project's accounting rate of return. Project Y: 17.10%, Project Z: 13.40%. 4. Determine each project's net present value. Project Y: $202,405.95, Project Z: $103,050.12.

Step-by-step explanation:

1. Compute each project's annual expected net cash flows:

Project Y: Sales - Total expenses = $355,000 - $273,500 = $81,500

Project Z: Sales - Total expenses = $345,000 - $281,125 = $63,875

2. Determine each project's payback period:

Project Y: Payback period = Initial investment / Annual net cash flow = $305,000 / $81,500 = 3.74 years

Project Z: Payback period = Initial investment / Annual net cash flow = $305,000 / $63,875 = 4.78 years

3. Compute each project's accounting rate of return:

Project Y: Accounting rate of return = (Average annual net income / Initial investment) x 100 = ($52,160 / $305,000) x 100 = 17.10%

Project Z: Accounting rate of return = (Average annual net income / Initial investment) x 100 = ($40,880 / $305,000) x 100 = 13.40%

4. Determine each project's net present value:

Project Y: Net present value = (Net cash flow year 1 / (1 + Discount rate)^1) + (Net cash flow year 2 / (1 + Discount rate)^2) + (Net cash flow year 3 / (1 + Discount rate)^3) - Initial investment = ($81,500 / (1 + 0.08)^1) + ($81,500 / (1 + 0.08)^2) + ($81,500 / (1 + 0.08)^3) - $305,000 = $202,405.95

Project Z: Net present value = (Net cash flow year 1 / (1 + Discount rate)^1) + (Net cash flow year 2 / (1 + Discount rate)^2) - Initial investment = ($63,875 / (1 + 0.08)^1) + ($63,875 / (1 + 0.08)^2) - $305,000 = $103,050.12