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### Financial & Managerial Accounting

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

# Aikman Company has an opportunity to invest in one of two projects. Project A requires a $240,000 investment for new machinery with a four-year life and no salvage value. Project B also requires a$240,000 investment for new machinery with a three-year life and no salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation, and cash flows occur evenly throughout each year. Company Project A Project BSales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $250,000$200,000Expenses Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,000 25,000 Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000 30,000 Overhead including depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,000 90,000 Selling and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . 18,000 18,000 Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193,000 163,000 Pretax income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57,000 37,000 Income taxes (30%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,100 11,100 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $39,900$ 25,900Required 1. Compute each project’s annual expected net cash flows. (Round net cash flows to the nearest dollar.) 2. Determine each project’s payback period. (Round the payback period to two decimals.) 3. Compute each project’s accounting rate of return. (Round the percentage return to one decimal.) 4. Determine each project’s net present value using 8% as the discount rate. For part 4 only, assume that cash flows occur at each year-end. (Round net present values to the nearest dollar.) Analysis Component 5. Identify the project you would recommend to management and explain your choice.

Project Y has a net cash flow of $143,500, the payback period is 2.44 years, the accounting rate of return is 32% and NPV is$125,286. Project Z has a net cash flow of $153,067, the payback period is 2.29 years, the accounting rate of return is 20.8% and NPV is$44,469. Project Y should be recommended.

See the step by step solution

## Step-by-Step SolutionStep 1: Computation of each project’s annual expected cash flows

 Project A Project B Net Income $39,900$25,900 Depreciation expense 60,000 80,000 Expected net cash flows $99,900$105,900

## Step 4: Calculation of net present value using 8% as the discount rate

Project Y

 Chart values are based on: N = 4I = 8% Select chart Amount x PV Factor = Present Value Present value of an annuity of 1 $99,900 3.3121$330,879 Present Value of cash inflows $330,879 Present value of cash outflows 240,000 Net Present value$90,879

Project Z

 Chart values are based on: N = 3I = 8% Select chart Amount x PV Factor = Present Value Present value of an annuity of 1 $105,900 2.5771$272,915 Present Value of cash inflows $272,915 Present value of cash outflows 240,000 Net Present value$32,915

## Step 5: Comparison

Project A must be recommended over project B as it has a higher accounting rate of return and a higher net present value.

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