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Financial & Managerial Accounting
Found in: Page 1090
Financial & Managerial Accounting

Financial & Managerial Accounting

Book edition 7th
Author(s) John J Wild, Ken W. Shaw, Barbara Chiappetta
Pages 1096 pages
ISBN 9781259726705

Short Answer

Cortino 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 $300,000 cost with an expected four-year life and a $20,000 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.

Expected annual sales of new product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,150,000

Expected annual costs of new product

Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000

Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 420,000

Overhead (excluding straight-line depreciation on new machine) . . . . . . . . . . . . . . 210,000

Selling and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000

Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30%

Required

1. Compute straight-line depreciation for each year of this new machine’s life. (Round depreciation amounts to the nearest dollar.)

2. Determine expected net income and net cash flow for each year of this machine’s life. (Round answers to the nearest dollar.)

3. Compute this machine’s payback period, assuming that cash flows occur evenly throughout each year. (Round the payback period to two decimals.)

4. Compute this machine’s accounting rate of return, assuming that income is earned evenly throughout each year. (Round the percentage return to two decimals.)

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.)

Depreciation is $70,000, net income is $35,000 and the net cash flow is $105,000. The payback period is 2.86 years, the accounting rate of return is 21.875% and the net present value is $70,914.

See the step by step solution

Step by Step Solution

Step-by-Step Step 1: Computation of Depreciation

Step 2: Determining net income and net cash flow

EXPECTED NET INCOME

Amount ($)

Amount ($)

Revenues:

Sales

$1,150,000

Expenses

Direct Materials

$300,000

Direct Labor

420,000

Overhead Excluding straight line Depreciation on a new machine

210,000

Selling and administration expenses

100,000

Straight-line depreciation on a new machine

70,000

Total Expenses

1,100,000

Income before taxes

50,000

Income tax expense

15,000

Net Income

$35,000

EXPECTED NET CASH FLOW

Net Income

$35,000

Straight-line depreciation on a new machine

70,000

Net cash flow

$105,000

Step 3: Computation of payback period

Step 4: Computation of accounting rate of return

Step 5: Computation of net present value

Cash flow

Select chart

Amount x

PV Factor =

Present Value

Annual Cash flow

Present Value of Annuity of 1

$105,000

3.3872

$355,656

Residual Value

Present Value of 1

$20,000

0.7629

15,258

Present value of cash inflows

$370,914

Present value of cash outflows

300,000

Net present value

$70,914

Most popular questions for Business-studies Textbooks

Grossman Corporation is considering a new project requiring a $30,000 investment in an asset having no salvage value. The project would produce $12,000 of pretax income before depreciation at the end of each of the next six years. The company’s income tax rate is 40%. In compiling its tax return and computing its income tax payments, the company can choose between two alternative depreciation schedules as shown in the table.

Straight-Line MACRS

Depreciation Depreciation*

Year 1 . . . . . . . . . . $ 3,000 $6,000

Year 2 . . . . . . . . . . 6,000 9,600

Year 3 . . . . . . . . . . 6,000 5,760

Year 4 . . . . . . . . . . 6,000 3,456

Year 5 . . . . . . . . . . 6,000 3,456

Year 6 . . . . . . . . . . 2,000 1,728

Totals . . . . . . . . . . . $30,000 $30,000

Required

1. Prepare a five-column table that reports amounts (assuming use of straight-line depreciation) for each of the following items for each of the six years: (a) pretax income before depreciation, (b) straight-line depreciation expense, (c) taxable income, (d) income taxes, and (e) net cash flow. Net cash flow equals the amount of income before depreciation minus the income taxes. (Round answers to the nearest dollar.)

2. Prepare a five-column table that reports amounts (assuming use of MACRS depreciation) for each of the following items for each of the six years: (a) pretax income before depreciation, (b) MACRS depreciation expense, (c) taxable income, (d) income taxes, and (e) net cash flow. Net cash flow equals the amount of income before depreciation minus the income taxes. (Round answers to the nearest dollar.)

3. Compute the net present value of the investment if straight-line depreciation is used. Use 10% as the discount rate. (Round the net present value to the nearest dollar.)

4. Compute the net present value of the investment if MACRS depreciation is used. Use 10% as the discount rate. (Round the net present value to the nearest dollar.)

Analysis Component

5. Explain why the MACRS depreciation method increases the net present value of this project.

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