Question

The following relates to a proposed equipment purchase:

Cost	$	156,000
Salvage value	$	4,500
Estimated useful life		4	years
Annual net cash flows	$	52,100
Depreciation method	Straight-line

Ignoring income taxes, the annual net income amount used to calculate the accounting rate of return is:

Multiple Choice

• $52,100

• $14,225

• $15,350

• $89,975

• $50,975
  
  

  Poe Company is considering the purchase of new equipment costing $81,000. The projected net cash flows are $36,000 for the first two years and $31,000 for years three and four. The revenue is to be received at the end of each year. The machine has a useful life of 4 years and no salvage value. Poe requires a 10% return on its investments. The present value of $1 and present value of an annuity of $1 for different periods is presented below. Compute the net present value of the machine.
  

  Periods	Present Value of $1 at 10%			Present Value of an Annuity of $1 at 10%
  1		0.9091			0.9091
  2		0.8264			1.7355
  3		0.7513			2.4869
  4		0.6830			3.1699

  Multiple Choice

• $(17,901).

• $(6,707).

• $17,901.

• $6,707.

• $25,944.

Answer 1

Solution :

Answer (1) The Answer is (b) $ 14,225.

Answer (2) The Answer is (d) $ 25,944.

Working :

(1) Net Income

ARR = Net Income / Investment

Net Income = Annual Cash Flow - Depreciation

Depreciation on Straight Line Basis = (Original Cost - Salavage Value) / Useful life

= ($ 156,000 - $ 4,500) / 4 Years

= $ 37,875

Net Income = $ 52,100 - $ 37,875

= $ 14,225

(2) NPV

NPV = PV of Cash Flows - Initial Investment

PV of Cash Flows :

Year	Cash Flow	PV Factor	PV of Cash Flows
1	$ 36,000	0.9091	$ 32,728
2	$ 36,000	0.8264	$ 29,750
3	$ 31,000	0.7513	$ 23,290
4	$ 31,000	0.6830	$ 21,173
			$ 106,941.30

NPV = $ 106,941.3 - $ 81,000

= 25,941.30 (difference is due to PV factor)

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