Ch 11 - Capital Budgeting Homework Alternate Exercise A Diane Manufacturing Company is considering investing $500,000 in new equipment with an estimated useful life of 10 years and no salvage value. The equipment is expected to produce $320,000 in cash inflows and $200,00o in cash outflows annually. The company uses straight- line depreciation, and has a 30% tax rate. a. Determine the annual estimated net income and net cash inflow. b. Calculate the payback period c. Calculate the accounting rate of return Problem E Merryll, Inc., is considering three different investments involving depreciable assets with no salvage value. The following data relate to these investments: Useful Life (years) 10 20 10 Investment Initial Cost After-tax net cash inflow $28,000 48,000 68,000 $140,000 240,000 360,000 The income tax rate is 40%. Management requires a minimum return on investment of 12% Rank these proposals using the following selection techniques: a. Payback period. b. Unadjusted rate of return. (remember to calculate and SUBTRACT depreciation from net cash inflow for net income) c. Discuss the results. Which project would you recommend and why? Discuss both payback period and rate of return in your analysis.
Exercise A:
Answer to Part a.
Net Income = (Cash Inflow – Cash Outflow - Depreciation) * (1 – Tax Rate)
Depreciation per year = (Cost – Salvage Value) / Useful Life
Depreciation per year = ($500,000 – 0) / 10 = $50,000
Net Income = ($320,000 - $200,000 - $50,000) * (1 – 0.30)
Net Income = $49,000
Net Cash Flow = Net Income + Depreciation
Net Cash Flow = $49,000 + $50,000
Net Cash Flow = $99,000
Answer to Part b.
Payback Period = Initial Investment / Annual Net Cash Flow
Payback Period = 500,000 / 99,000
Payback Period = 5.05 years
Answer to Part c.
Accounting Rate of Return = Annual Net Income / Average Investment * 100
Average Investment = (500,000 + 0) /2 = $250,000
Accounting Rate of Return = 49,000 / 250,000 * 100
Accounting Rate of Return = 19.60%
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