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Financial & Managerial Accounting
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Short Answer

Retsa Company is considering an investment in technology to improve its operations. The investment will require an initial outlay of $800,000 and will yield the following expected cash flows. Management requires investments to have a payback period of two years, and it requires a 10% return on its investments.

Period Cash Flow

1 . . . . . . . . . . . . $450,000

2 . . . . . . . . . . . . 400,000

3 . . . . . . . . . . . . 350,000

4 . . . . . . . . . . . . 300,000

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.

5. Compare your answers for parts 1 through 4 with those for Problem 24-5B. What are the causes of the differences in results and your conclusions?

The payback period is 1.9 years and the break-even time is 2.2 years and the net present value is $407,510. This project should be accepted and the values are opposite of which are given in 24-5B.

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

-$800,000

-$800,000

1

450,000

-350,000

2

400,000

50,000

3

350,000

400,000

4

300,000

700,000

$700,000

Calculation of the payback period:

Payback occurs between years:

1

And year

2

Calculate the portion of the year:

The payback period will be 1.9 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

-$800,000

1.0000

-$800,000

-$800,000

1

450,000

0.9091

409,095

-390,905

2

400,000

0.8264

330,560

-60,345

3

350,000

0.7513

262,955

202,610

4

300,000

0.6830

204,900

407,510

$700,000

Break-even time occurs between year 2 and the year 3

Break-even time = 2.2 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 $407,510 and the break-even time is 3.07 years.

Step 5: Comparison

24-5B

24-6B

Causes

1

2.4 years

1.9 years

The cash flow was higher in the beginning and lower in the ending in 24-6B and vice versa in 24-5B

2

2.8 years

2.2 years

The cash flow was higher in the beginning and lower in the ending in 24-6B and vice versa in 24-5B

3

$369,840

$407,510

The cash flow was higher in the beginning and lower in the ending in 24-6B and vice versa in 24-5B

4

Yes

Yes

Both the project should be accepted

Conclusion: In the problem, 24-5B values of cash flow are lower in the beginning and got increased but in the problem 24-6B the values are opposite of that of problem 24-5A.

Most popular questions for Business-studies Textbooks

Archer Foods has a freezer that is in need of repair and is considering whether to replace the old freezer with a new freezer or have the old freezer extensively repaired. Information about the two alternatives follows. Management requires a 10% rate of return on its investments.

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

Cost of old freezer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $75,000

Cost of repair . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000

Annual expected revenues generated . . . . . . . . . . . . . . . 63,000

Annual cash operating costs after repair . . . . . . . . . . . . . 55,000

Salvage value of old freezer in 8 years . . . . . . . . . . . . . . 3,000

Alternative 2: Sell the old freezer and buy a new one. The new freezer is larger than the old one and will allow the company to expand its product offerings, thereby generating more revenues. Also, it is more energy efficient and will yield substantial operating cost savings.

Cost of new freezer............................. $150,000

Salvage value of old freezer now.................. 5,000

Annual expected revenues generated . . . . . . . . . . . . . . 68,000

Annual cash operating costs . . . . . . . . . . . . . . . . . . . . . . 30,000

Salvage value of new freezer in 8 years . . . . . . . . . . . . . 8,000

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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