Rob Roy Corporation has been using its present facilities at its annual full cap
ID: 2332294 • Letter: R
Question
Rob Roy Corporation has been using its present facilities at its annual full capacity of 10,000 units for the last 3 years. Still, the company is unable to keep pace with continuing demand for the product that is estimated to be 25,000 units annually. This demand level is expected to continue for at least another 4 years. To expand manufacturing capacity and take advantage of the demand, Rob Roy must acquire equipment costing $1.000,000. The equipment will double the current production quantity. This equipment has a useful life of 10 years and can be sold for $200,000 at the end of year 4 or $30.000 at the end of year 10. Analysis of current operating data provides the following information Sales price Variable costs: $232 Hanufacturing Harketing s 97 18$107 Fixed costs: Hanufacturing Other $ 45 25 Pretax operating income s 55 The fixed costs include depreciation expense of the current equipment. The new equipment will not change variable costs, but the firm will incur additional fixed manufacturing costs (excluding depreciation on the new machine) of $250,000 annually. The firm needs to spend an additional $200.000 in fixed marketing costs per year for additional sales. Rob Roy is in the 35% tax bracket Management has set aminimum rate of return of 15.0% after-tax for all capital investments. Assume, for simplicity, that MACRS depreciation rules do not apply. Part 1 Required: 1. Assume that the equipment will be depreciated over a 4-year period using the straight-ine method. What effects will the new equipment have on after-tax operating income in each of the 4 years? 2. What effect will the new equipment have on after-tax cash inflows in each of the 4 years? 3 Compute the proposed investment's payback period (in years) under the assumption that after-tax cash inflows occur evenly throughout the year (Round your answer to 2 decimal places.) ompute the accounting (book) rate of return (ARR) based on the average investment. (Round your answer to 2 decimal places.) 5 Compute the net present value (NPV) of the proposed investment (Use both the builit-in function in Excel (NPV) and the tables presented in Appendix C to determine the present value of the after-tax cash fiows.) (Round your answer to nearest whole dollarExplanation / Answer
Solution 1:
Current operating income = $55 * 10000 = $550,000
Additional annual contribution margin from new equipment = ($232 - $107) * 10000 = $1,250,000
Additional cash fixed cost on new equipment = $250,000 + $200,000 = $450,000
Depreciation on new equipment = ($1,000,000 - $200,000) / 4 = $200,000
Therefore after tax operating income will increase by $390,000 on purchasing new equipment.
Solution 2:
Effects of the new equipment on after tax cash inflows in each of the first three years = Operating income from new equipment + Depreciation = $390,000 + $200,000 = $590,000
Effects of the new equipment on after tax cash inflows in the 4th year = Annual cash inflows + Salvage value
= $590,000 + $200,000 = $790,000
Solution 3:
Payback period = Initital investment / Annual cash inflows = $1,000,000 / $590,000 = 1.69 Years
Solution 4:
Accounting rate of return = Average annual income / Average investment
Average investment = (Cost + Salvage value) / 2 = ($1,000,000 + $200,000)/2 = $600,000
Accounting rate of return = $390,000 / $600,000 = 65%
Note: I have answered first 4 parts of the question as per chegg policy, kindly post separate question for answer of remaining parts.
Computation of after tax operating income from new equipment - Rob Roy Corporation Particulars Amount Additional Contribution margin $1,250,000.00 Less: additional cash fixed cost $450,000.00 Les: Depreciaion on new equipment $200,000.00 Pretax operating income from new equipment $600,000.00 Income tax (35%) $210,000.00 After tax operating income $390,000.00Related Questions
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