Managerial Accounting Chapter 10 – P4. Capital Investment Decision: Comprehensiv

Question

Managerial Accounting
Chapter 10 – P4. Capital Investment Decision: Comprehensive
Edge Company’s Production vice president believes keeping up-to-date with technological changes is what makes the company successful and feels that a machine introduced recently would fill an important need. The machine has an estimated useful life of four years, a purchase price of $250,000 and a residual value of $25,000. The company controller has estimated average annual net income of $11,250 and the following cash flows for the new machines:
Cash flow Estimates
Year Cash inflows Cash outflows Net cash Inflows
1 325,000 250,000 75,000
2 320,000 250,000 70,000
3 315,000 250,000 65,000
4 310,000 250,000 60,000
The company uses a 12% minimum rate of return and a three-year payback period for capital investment evaluation processes.

Required:
1. Analyze the data about the machine. Use the following evaluation approaches in your analysis.
a. Net present value method (round to the nearest dollar).
b. Accounting rate of return method (round percentage to one decimal place).
c. Payback period method (round to one decimal place).
Hint: Use Tables 1 and 2 in Appendix A.

Explanation / Answer

a) Net present value at 12%

Amount in $

NPV -26,944

NPV at 8%

NPV --6,465

Difference in NPV =-20,479

difference in rate=12%-8%=4%

b) accounting rate of return=12%+26,944*4%/(-20,479)=12%-5.26%=6.74%

c) pay back period=3+$15,000/60,000=3+0.25=3.25

cash out flow=$250,000-$25,000=$225,000

year    cash flow pv factor@12% Pv Cash flow 0 -250,000 1 -250,000 1 75,000 0.8929 66,968 2 70,000 0.7972 55,804 3 65,000 0.7118 46,267 4 60,000 0.6355 38,130 4 25,000 0.6355 15,888

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