Downhill Gear is planning to expand its product line, which requires investment

Question

Downhill Gear is planning to expand its product line, which requires investment of $360,000 in special-purpose machinery.  The machinery has a useful life of six years and no salvage value.  The estimated annual results of offering the new products are as follows:

Revenue................................................................................

$400,000

Expenses (including straight-line depreciation)..........................

(380,000

)

Increase in net income...........................................................

$  20,000

All revenue from the new products and all expenses (except depreciation) will be received or paid in cash in the same period as recognized for accounting purposes.

The payback period for this proposed investment is:

Answer

Revenue................................................................................

$400,000

Expenses (including straight-line depreciation)..........................

(380,000

)

Increase in net income...........................................................

$  20,000

Explanation / Answer

Hi,

Please find the answer as follows:

Part A:

Payback Period = Initial Investment/Annual Cash Inflow

Annual Cash Inflow = Net Income + Depreciation = 20000 + 360000/6 = 80000

Payback Period = 360000/80000 = 4.5 Years

Part B:

Return on Average Investment = Average Income/Average Investment = 20000/180000/2*100 = 11.1%

Part C:

NPV = - 360000 + 80000*4.111 = -31120

Thanks.

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