Factor Company is planning to add a new product to its line. To manufacture this
ID: 2491339 • Letter: F
Question
Factor Company is planning to add a new product to its line. To manufacture this product, the company needs to buy a new machine at a $503,000 cost with an expected four-year life and a $11,000 salvage value. All sales are for cash, and all costs are out-of-pocket, except for depreciation on the new machine. Additional information includes the following. (FV of $1, PV of $1, FVA of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Expected annual sales of new product $ 1,880,000 Expected annual costs of new product Direct materials 485,000 Direct labor 676,000 Overhead (excluding straight-line depreciation on new machine) 335,000 Selling and administrative expenses 148,000 Income taxes 32 %
Required: 1. Compute straight-line depreciation for each year of this new machine’s life.
Determine expected net income and net cash flow for each year of this machine’s life.
3.
Compute this machine’s payback period, assuming that cash flows occur evenly throughout each year.
4.
Compute this machine’s accounting rate of return, assuming that income is earned evenly throughout each year.
Compute the net present value for this machine using a discount rate of 6% and assuming that cash flows occur at each year-end. (Hint: Salvage value is a cash inflow at the end of the asset’s life.) (Do not round intermediate calculations.)
2.Determine expected net income and net cash flow for each year of this machine’s life.
Explanation / Answer
1
Calculation of straight-line depreciation for each year of this new machine’s life:
Cost of Machine
$ 503,000
Salvage value
$ 11,000
Life (Years )
4
Straight-line depreciation for each year of this new machine’s life
$ 123,000
(Cost - Salvage value) / life
(503000-11000) / 4
2
Calculation of expected net income and net cash flow for each year:
Expected Annual Sales
$ 1,880,000
Less: Expected annual costs:
Direct materials
$ (485,000)
Direct labor
$ (676,000)
Overhead
$ (335,000)
Depreciation
$ (123,000)
Selling and administrative expenses
$ (148,000)
Income before tax
$ 113,000
Less: Tax (113000*32%)
$ (36,160)
Net income
$ 76,840
Add: Depreciation
$ 123,000
Net Cash flows
$ 199,840
3
Calculation of Machine's Payback Period:
Cost of Machine (A)
$ 503,000
Net Cash flows (B)
$ 199,840
Payback Period (A/B)
2.52 Years
4
Calculation of machine’s accounting rate of return:
Cost of Machine (A)
$ 503,000
Annual Net income (B)
$ 76,840
Accounting rate of return = B/A =
15.28%
1
Calculation of straight-line depreciation for each year of this new machine’s life:
Cost of Machine
$ 503,000
Salvage value
$ 11,000
Life (Years )
4
Straight-line depreciation for each year of this new machine’s life
$ 123,000
(Cost - Salvage value) / life
(503000-11000) / 4
2
Calculation of expected net income and net cash flow for each year:
Expected Annual Sales
$ 1,880,000
Less: Expected annual costs:
Direct materials
$ (485,000)
Direct labor
$ (676,000)
Overhead
$ (335,000)
Depreciation
$ (123,000)
Selling and administrative expenses
$ (148,000)
Income before tax
$ 113,000
Less: Tax (113000*32%)
$ (36,160)
Net income
$ 76,840
Add: Depreciation
$ 123,000
Net Cash flows
$ 199,840
3
Calculation of Machine's Payback Period:
Cost of Machine (A)
$ 503,000
Net Cash flows (B)
$ 199,840
Payback Period (A/B)
2.52 Years
4
Calculation of machine’s accounting rate of return:
Cost of Machine (A)
$ 503,000
Annual Net income (B)
$ 76,840
Accounting rate of return = B/A =
15.28%
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