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Most Company has an opportunity to invest in one of two new projects. Project Y requires a $340,000 investment for new machinery with a six-year life and no salvage value. Project Z requires a $340,000 investment for new machinery with a five-year life and no salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation, and cash flows occur evenly throughout each year. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

2. Determine each project’s payback period.

Project Y Project Z Sales $ 385,000 $ 308,000 Expenses Direct materials 53,900 38,500 Direct labor 77,000 46,200 Overhead including depreciation 138,600 138,600 Selling and administrative expenses 28,000 27,000 Total expenses 297,500 250,300 Pretax income 87,500 57,700 Income taxes (26%) 22,750 15,002 Net income $ 64,750 $ 42,698

Explanation / Answer

Payback period = Project Investment / Net operating Cash flow per year Payback period for Project Y = $3,40,000 / $1,21,417 = 2.80 Years Payback period for Project Z = $3,40,000 / $1,10,698 = 3.07 Years Working Depreciation of Project Y using straight line method = (Cost - salvage value)/useful life = ($340000-$0)/6 years = $56,667 Depreciation of Project Z using straight line method = (Cost - salvage value)/useful life = ($340000-$0)/5 years = $68,000 Net Operating cash flow per year of Project Y = Net Income + Depreciation = $64,750 + $56,667 = $1,21,417 Net Operating cash flow per year of Project Z = Net Income + Depreciation = $42,698 + $68,000 = $1,10,698

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