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Financial & Managerial Accounting
Found in: Page 1091
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

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 B

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $250,000 $200,000

Expenses 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 $ 25,900

Required

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 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 2: Computation of payback period

Step 3: Computation of accounting rate of return

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

Project Y

Chart values are based on:

N = 4

I = 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 outflows240,000
Net Present value$90,879

Project Z

Chart values are based on:

N = 3

I = 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 outflows240,000
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.

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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