Factor Company is planning to add a new product to its line

Factor Company is planning to add a new product to its line. To manufacture this product, the company needs to buy a new machine at a $499,000 cost with an expected four-year life and a $15,000 salvage value. All sales are for cash, and all costs are out-of-pocket, except for depreciation on the new machine. Additional information includes the following. (PV of $1, FV of $1, PVA of $1, and FVA of (Use appropriate factor(s) from the tables provided.) Expected annual sales of new product Expected annual costs of new product 2,000,000 Direct materials Direct labor overhead (excluding straight-line depreciation on new machine Selling and administrative expenses Income taxes 475,000 674,000 338,000 156,000 369 Required: 1. Compute straight-line depreciation for each year of this new machine\'s life. 2. Determine expected net income and net cash flow for each year of this machine\'s life. 3. Compute this machine\'s payback period, assuming that cash flows occur evenly throughout each year. 4. Compute this machine\'s accounting rate of return, assuming that income is earned evenly throughout each year 5. Compute the net present value for this machine using a discount rate of 7% and assuming that cash flows occur at each year-end. (Hint Salvage value is a cash inflow at the end of the asset\'s life.)

Solution

1 Straight-line depreciation=(Cost of invenstment-Salvage value)/Useful life of the asset=(499000-15000)/4=$ 121000 2 Expected net income: Expected sales 2000000 Less: Expected costs Direct materials 475000 Direct labor 674000 Overhead 338000 Selling and administrative expense 156000 Depreciation 121000 1764000 Income before taxes 236000 Less:Taxes @ 36% 84960 Net income 151040 Expected net cashflow: Income before taxes 236000 Add:depreciation 121000 Cash flow before taxes 357000 Less:Taxes @ 36% 128520 Net cashflow 228480 3 Payback period=Cost of investment/Annual net cashflow=499000/228480=2.18 year 4 Accounting rate of return=Annual net income/Annual average investment Annual average investment=(Book value of asset at the beginning of the year+Book value of asset at the end of the year)/2=(499000+15000)/2=257000 Accounting rate of return=151040/257000=58.77% 5 n=4 years i=7% Cashflow Amount PV Factor Present Value Annual cash flow Present value for 4 years @ 7% 228480 3.387211 773910 Residual value Present value for 4th year @ 7% 15000 0.762895 11443 Cash inflow 785353 Less: Initial investment 499000 Net present value 286353