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 $620,000 cost with an expected four-year life and a $34,000 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 $ 2,190,000 Expected annual costs of new product Direct materials 494,000 Direct labor 686,000 Overhead (excluding straight-line depreciation on new machine) 476,000 Selling and administrative expenses 174,000 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 4% 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) depreciation expense per year = $146,500

2) net income:

years 1 - 4 = $149,450

net cash flows:

year 0 = -$620,000

year 1 = $295,950

year 2 = $295,950

year 3 = $295,950

year 4 = $329,950

3) payback period = 2.09 years

4) accounting rate of return = 24.1%

5) net present value (NPV) = $483,330.83

Step-by-step explanation:

purchase cost of the machine $620,000

depreciation expense per year = ($620,000 - $34,000) / 4 = $146,500

expected annual sales $2,190,000

direct materials $494,000

direct labor $686,000

overhead (excluding depreciation) $476,000

S&A expenses $174,000

total costs (excluding depreciation) = $1,830,000

income taxes 30%

net income per year = ($2,190,000 - $1,830,000 - $146,500) x 70% = $149,450

net cash flow (years 1 - 3) = $149,450 + $146,500 = $295,950

net cash flow (year 4) = $149,450 + $146,500 + $34,000 = $329,950

payback period = $620,000 / $295,950 = 2.09 years

accounting rate of return = $149,450 / $620,000 = 24.1%

NPV, using a financial calculator = $483,330.83