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 $800,000 cost with an expected four-year life and a $52,000 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. Round PV factor value to 4 decimal places.)

Expected annual sales of new product $ 2, 640,000
Expected annual costs of new product
Direct materials 512,000
Direct labor 704,000
Overhead (excluding straight-line depreciation on new machine)656,000
Selling and administrative expenses 192,000
Income taxes 30 %
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 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 3% 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.)

Answer 1

1. Compute straight-line depreciation for each year of this new machine’s life.

• depreciation per year $187,000

2. Determine expected net income and net cash flow for each year of this machine’s life.

• net income per year $272,300
• net cash flow for years 1 - 4 = $459,300
• net cash flow year 5 = $511,300

3. Compute this machine’s payback period, assuming that cash flows occur evenly throughout each year.

• 1.74 years

4. Compute this machine’s accounting rate of return, assuming that income is earned evenly throughout each year.

• 34%

5. Compute the net present value for this machine using a discount rate of 3% and assuming that cash flows occur at each year-end.

• $1,348,316

Step-by-step explanation:

machine's cost $800,000

useful life 4 years, with $52,000 salvage value

depreciation per year = ($800,000 - $52,000) / 4 years = $187,000

net income = $2,640,000 - $512,000 - $704,000 - $187,000 - $656,000 - $192,000 = $389,000 x 0.7 = $272,300

net cash flow = $272,300 + $187,000 = $459,300

payback period = $800,000 / $459,300 = 1.74 years

accounting rate of return = $272,300 / $800,000 = 34%

NPV = -$800,000 + ($459,300 x 3.7171 annuity factor) + ($511,300/1.03⁵) = -$800,000 + $1,707,264 + $441,052 = $1,348,316