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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

Sentinel Company is considering an investment in technology to improve its operations. The investment will require an initial outlay of $250,000 and will yield the following expected cash flows. Management requires investments to have a payback period of three years, and it requires a 10% return on investments.

Period Cash Flow

1 . . . . . . . . . . . . $ 47,000

2 . . . . . . . . . . . . 52,000

3 . . . . . . . . . . . . 75,000

4 . . . . . . . . . . . . 94,000

5 . . . . . . . . . . . . 125,000

Required

1. Determine the payback period for this investment. (Round the answer to one decimal.)

2. Determine the break-even time for this investment. (Round the answer to one decimal.)

3. Determine the net present value for this investment.

Analysis Component

4. Should management invest in this project? Explain.

The payback period is 3.8 years and the break-even time is 4.6 years and the net present value is $33,864.

See the step by step solution

Step by Step Solution

Step-by-Step SolutionStep 1: Computation of payback period

Year

Cash Inflow (outflow)

Cumulative net cash inflow (outflow)

0

-$250,000

-$250,000

1

47,000

-203,000

2

52,000

-151,000

3

75,000

-76,000

4

94,000

18,000

5

125,000

143,000

$143,000

Calculation of the payback period:

Payback occurs between years:

3

And year

4

Calculate the portion of the year:

The payback period will be 3.8 years.

Step 2: Break-even time for the investment

Year

Cash inflow (outflow)

Table factor

Present value of cash flows

Cumulative present value of cash flows

0

-$250,000

1.0000

-$250,000

-$250,000

1

47,000

0.9091

42,728

-207,272

2

52,000

0.8264

42,973

-164,299

3

75,000

0.7513

56,348

-107,951

4

94,000

0.6830

64,202

-43,749

5

125,000

0.6209

77,613

33,864

$143,000

Break-even time occurs between year: 4 and the year 5

Break-even time = 4.6 years

Step 3: The net present value of this investment

Step 4: Should be invested

The management should invest in the project as the project has a net present value of $33,864 and the break-even time is 4.6 years.

Most popular questions for Business-studies Textbooks

Interstate Manufacturing is considering either replacing one of its old machines with a new machine or having the old machine overhauled. Information about the two alternatives follows. Management requires a 10% rate of return on its investments.

Alternative 1: Keep the old machine and have it overhauled. If the old machine is overhauled, it will be kept for another five years and then sold for its salvage value.

Cost of old machine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $112,000

Cost of overhaul . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150,000

Annual expected revenues generated . . . . . . . . . . . . . . . . . . 95,000

Annual cash operating costs after overhaul . . . . . . . . . . . . . . 42,000

Salvage value of old machine in 5 years . . . . . . . . . . . . . . . . 15,000

Alternative 2: Sell the old machine and buy a new one. The new machine is more efficient and will yield substantial operating cost savings with more product being produced and sold.

Cost of new machine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300,000

Salvage value of old machine now . . . . . . . . . . . . . . . . . . 29,000

Annual expected revenues generated . . . . . . . . . . . . . . . 100,000

Annual cash operating costs . . . . . . . . . . . . . . . . . . . . . . . 32,000

Salvage value of new machine in 5 years . . . . . . . . . . . . 20,000

Required 1. Determine the net present value of alternative 1.

2. Determine the net present value of alternative 2.

3. Which alternative do you recommend that management select? Explain.

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