Franklin Electronics is considering investing in manufacturing equipment expecte

Question

Franklin Electronics is considering investing in manufacturing equipment expected to cost $270,000. The equipment has an estimated useful life of four years and a salvage value of $ 16,000. It is expected to produce incremental cash revenues of $135,000 per year. Franklin has an effective income tax rate of 30 percent and a desired rate of return of 12 percent. (PV of $1 and PVA of $1)

Required

a) Determine the net present value and the present value index of the investment, assuming that Franklin uses straight-line depreciation for financial and income tax reporting.

b) Determine the net present value and the present value index of the investment, assuming that Franklin uses double-declining-balance depreciation for financial and income tax reporting.

c) Determine the payback period and unadjusted rate of return (use average investment), assuming that Franklin uses straight-line depreciation.

d) Determine the payback period and unadjusted rate of return (use average investment), assuming that Franklin uses double-declining-balance depreciation. (Note: Use average annual cash flow when computing the payback period and average annual income when determining the unadjusted rate of return.)

Explanation / Answer

a) Statement showing NPV

Present value index= PV of cash inflow/PV of cash outflow

=355059/270000

=1.3150

C) Payback period = Initial investment/Cash flow

=270000/113550

=2.377 years

unadjusted rate of return = PAT/Investment

=50050/270000

=18.54%

b)

Straight line method depreciation rate = 1/4 = 25%

Double declining balance method rate = 25%*2 = 50%

Statement showing depreciation

Statement showing NPV using double declining balance method

D)

Payback period

Statement showing cummulative cash flow

Using interpolation method we can find Payback period

=20250/104625

=0.1935 years

Payback period = 2+0.1935

=2.1935 years

unadjusted rate of return = Average PAT/ Investment

=50203/270000

=18.59%

Particulars 0 1 2 3 4 Total Cost of Manyfacturing index -270000 Incremental cash revenue 135000 135000 135000 135000 Depreciation 63500 63500 63500 63500 PBT 71500 71500 71500 71500 Tax @ 30% 21450 21450 21450 21450 PAT 50050 50050 50050 50050 Add: depreciation 63500 63500 63500 63500 Annual cash flow 113550 113550 113550 113550 Salvage value 16000 Total cash inflow -270000 113550 113550 113550 129550 PVIF @ 12%              1.0000             0.8929                       0.7972                        0.7118                      0.6355 Present value -270000 101384 90521 80823 82331 85059

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