Bowman Corporation is considering an investment in special-purpose equipment to

Question

Bowman Corporation is considering an investment in special-purpose equipment to enable the company to obtain a four-year government contract for the manufacture of a special item. The equipment costs $178,000 and would have no salvage value when the contract expires at the end of the four years. Estimated annual operating results of the project are as follows.

  

   

All revenue and all expenses other than depreciation will be received or paid in cash in the same period as recognized for accounting purposes.

a. Payback period. (Round pay back period year to 2 decimal places.)

b. Return on average investment. (Round your percentage answer to 1 decimal place (i.e., 0.123 to be entered as 12.3).)

c. Net present value of the proposal to undertake contract work, discounted at an annual rate of 6 percent. (Refer to the annuity table in Exhibit 26–4.) (Round your "PV factors" to 3 decimal places.)

Revenue from contract sales $ 301,000 Expenses other than depreciation $ 212,000 Depreciation (straight-line basis) 44,500 256,500 Increase in net income from contract work $ 44,500

Explanation / Answer

1) Annual cash flow = 44500+44500 = 89000

Payback period = 178000/89000 = 2 Years

2) Return on average investment = 44500*100/89000 = 50%

3) Net present value = (89000*3.465-178000) = 130385

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