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 $503,000 cost with an expected four-year life and a $11,000 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	$	1,850,000
Expected annual costs of new product
Direct materials		475,000
Direct labor		675,000
Overhead (excluding straight-line depreciation on new machine)		338,000
Selling and administrative expenses		178,000
Income taxes		40	%

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 8% 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.)

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

Straight-line depreciation

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

Expected Net Income
Revenues
Expenses
Expected Net Cash Flow

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

Payback Period
Choose Numerator:	/	Choose Denominator:	=	Payback Period
	/		=	Payback period
			=

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

Accounting Rate of Return
Choose Numerator:	/	Choose Denominator:	=	Accounting Rate of Return
	/		=	Accounting rate of return

Compute the net present value for this machine using a discount rate of 8% 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.) (Do not round intermediate calculations. Amounts to be deducted should be indicated by a minus sign.)

	Chart Values are Based on:
	n =
	i =
Cash Flow	Select Chart	Amount	x	PV Factor	=	Present Value
Annual cash flow					=
Residual value					=
	Net present value

Answer 1

Answer 1.

Cost of Machine = $503,000
Salvage Value = $11,000
Useful Life = 4 years

Annual Depreciation = (Cost of Machine - Salvage Value) / Useful Life
Annual Depreciation = ($503,000 - $11,000) / 4
Annual Depreciation = $123,000

Answer 2.

Answer 3.

Payback Period = Cost of Investment / Annual Net Cash Flow
Payback Period = $503,000 / $159,600
Payback Period = 3.15 years

Answer 4.

Average Investment = (Cost of Machine + Salvage Value) / 2
Average Investment = ($503,000 + $11,000) / 2
Average Investment = $257,000

Accounting Rate of Return = Annual Net Income / Average Investment
Accounting Rate of Return = $36,600 / $257,000
Accounting Rate of Return = 14.24%

Answer 5.