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:

Expected annual sales of new product $1,910,000
Expected annual costs of new product:
Direct materials 495,000
Direct labor 674,000
Overhead (excluding straight-line depreciation on new machine) 335,000
Selling and administrative expenses 159,000
Income taxes 38%
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 cash flows occur evenly throughout each year.
4. Compute this machine's accounting rate of return, assuming income is earned evenly throughout each year.
5. Compute net present value, using a discount rate of 6% and that assuming that cash flows occur at each year-end.

Answer 1

1. $116,000

2. Net Income = $81,220 and Net Cash flow = $247,000

3. The payback period is 1 year and 11 months .

4. 31.85 %

5. $368,881.09

Step-by-step explanation:

Straight Line Method charges a fixed amount of depreciation expense over the life of an asset.

Depreciation Expense = (Cost - Residual Value) / Estimated Useful Life

= ($487,000 - $23,000) / 4

= $116,000

Net Income = Sales - Expenses

Sales $1,910,000

Less Expenses :

Direct materials ($495,000)

Direct labor ($674,000)

Overhead ( $335,000 + $116,000) ($451,000)

Selling and administrative expenses ($159,000)

Operating Income before tax $131,000

Income tax at 38% ($49,780)

Net Income $81,220

Net Cash Flow Calculation :

Operating Income before tax $131,000

Add Depreciation Expense $116,000

Net Cash flow $247,000

Payback period

Payback period = Year 1 + Year 2

$487,000 = $247,000 + $240,000 / $247,000 × 12

= 1 year, 11 months

Therefore, the payback period is 1 year and 11 months .

Accounting Rate of Return = Average Profits / Average Investment × 100

Where, Average Profits = Sum of Profits ÷ Number of Years

= ($81,220 × 4) ÷ 4

= $81,220

and Average Investment = (Initial Investment + Scrape Value) ÷ 2

= ($487,000 + $23,000) ÷ 2

= $255,000

Therefore, Accounting Rate of Return = $81,220 / $255,000 × 100

= 31.85 %

NET PRESENT VALUE (NPV)

Calculation of NPV of Project A using a Financial Calculator :

($487,000) Cfj

$247,000 Cfj

$247,000 Cfj

$247,000 Cfj

$247,000 Cfj

6 I/Yr

Shift NPV $368,881.09