Express Corporation wants to buy a new stamping machine. The machine will provid
ID: 2490223 • Letter: E
Question
Express Corporation wants to buy a new stamping machine. The machine will provide the company with a new product line: pressed food trays for kitchens. Two machines are being considered; the data for each machine follow. ETZ Machine LKR Machine Cost of machine $350,000 $370,000 Net income $39,204 $48,642 Annual net cash inflows $64,404 $75,642 Residual value $28,000 $40,000 Estimated useful life in years 10 10 The company’s minimum rate of return is 16 percent, and the maximum allowable pay- back period is 5.0 years. Required 1. Compute the net present value for each machine. (Round to the nearest dollar.) 2. Compute the accounting rate of return for each machine. (Round to one decimal place.) 3. Compute the payback period for each machine. (Round to one decimal place.) 4. Accounting Connection From the information generated in requirements 1–3, decide which machine should be purchased. Why?
Explanation / Answer
1
Calculation of Net present value of each Machine:
ETZ Machine
LKR Machine
Cost of Machine (A)
$ (350,000.00)
$ (370,000.00)
Annual net cash inflows (CF)
$ 64,404.00
$ 75,642.00
PV of $ 1 Annuity (16%, 10 years) (PVA)
4.83323
4.83323
Present value of net cash inflows = CF*PVA = (B)
$ 311,279.18
$ 365,594.99
Residual Value (RV)
$ 28,000.00
$ 40,000.00
PV of $ 1 (16%, 10th year) (PV)
0.22668
0.22668
Present value of residual value = RV*PV = (C)
$ 6,347.14
$ 9,067.34
Net Present value = A+B+C =
$ (32,374)
$ 4,662
2
Calculation of Accounting Rate of return for each Machine:
ETZ Machine
LKR Machine
Cost of Machine (A)
$ 350,000.00
$ 370,000.00
Annual Net income (B)
$ 39,204.00
$ 48,642.00
Accounting Rate of Return = A/B =
11.2%
13.1%
3
Calculation of Payback Period for each machine :
ETZ Machine
LKR Machine
Cost of Machine (A)
$ 350,000.00
$ 370,000.00
Annual net cash inflows (CF)
$ 64,404.00
$ 75,642.00
Payback Period (Years)= A/CF =
5.4
4.9
4
Machine ETZ has Negative Net present value, Lower Accounting rate of return and Payback period is more than the maximum allowed.
Machine LKR has Positive Net present value, Higher Accounting rate of return and Payback period is less than the maximum allowed.
Hence machine LKR is the best option.
1
Calculation of Net present value of each Machine:
ETZ Machine
LKR Machine
Cost of Machine (A)
$ (350,000.00)
$ (370,000.00)
Annual net cash inflows (CF)
$ 64,404.00
$ 75,642.00
PV of $ 1 Annuity (16%, 10 years) (PVA)
4.83323
4.83323
Present value of net cash inflows = CF*PVA = (B)
$ 311,279.18
$ 365,594.99
Residual Value (RV)
$ 28,000.00
$ 40,000.00
PV of $ 1 (16%, 10th year) (PV)
0.22668
0.22668
Present value of residual value = RV*PV = (C)
$ 6,347.14
$ 9,067.34
Net Present value = A+B+C =
$ (32,374)
$ 4,662
2
Calculation of Accounting Rate of return for each Machine:
ETZ Machine
LKR Machine
Cost of Machine (A)
$ 350,000.00
$ 370,000.00
Annual Net income (B)
$ 39,204.00
$ 48,642.00
Accounting Rate of Return = A/B =
11.2%
13.1%
3
Calculation of Payback Period for each machine :
ETZ Machine
LKR Machine
Cost of Machine (A)
$ 350,000.00
$ 370,000.00
Annual net cash inflows (CF)
$ 64,404.00
$ 75,642.00
Payback Period (Years)= A/CF =
5.4
4.9
4
Machine ETZ has Negative Net present value, Lower Accounting rate of return and Payback period is more than the maximum allowed.
Machine LKR has Positive Net present value, Higher Accounting rate of return and Payback period is less than the maximum allowed.
Hence machine LKR is the best option.
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