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 $511,000 cost with an expected four-year life and a $19,000 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.)

Expected annual sales of new product	$	1,920,000
Expected annual costs of new product
Direct materials		460,000
Direct labor		676,000
Overhead (excluding straight-line depreciation on new machine)		336,000
Selling and administrative expenses		150,000
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 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 7% 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

Answer to Part 1.

Straight Line Depreciation per year = (Cost – Salvage Value) / Useful Life
Straight Line Depreciation per year = (511,000 – 19,000) / 4
Straight Line Depreciation per year = 492,000 / 4
Straight Line Depreciation per year = $123,000

Answer to Part 3.

Payback Period = Initial Investment / Annual Net Cash Flow
Payback Period = 511,000 / 231,500
Payback Period = 2.21 years

Answer to Part 4.

Accounting Rate of Return = Annual after tax Net Income / Average Investment * 100
Average Investment = (511,000 + 19,000) / 2
Average Investment = $265,000

Accounting Rate of Return = 108,500 / 265,000 * 100
Accounting Rate of Return = 40.94%