Most Company has an opportunity to invest in one of two new projects. Project Y

Question

Most Company has an opportunity to invest in one of two new projects. Project Y requires a $330,000 investment for new machinery with a six-year life and no salvage value. Project Z requires a $330,000 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.)

1. Compute each project’s annual expected net cash flows.

Determine each project’s payback period.

Compute each project’s accounting rate of return.

Determine each project’s net present value using 9% as the discount rate. Assume that cash flows occur at each year-end. (Round your intermediate calculations.)

Project Y Project Z Sales $ 375,000 $ 300,000 Expenses Direct materials 52,500 37,500 Direct labor 75,000 45,000 Overhead including depreciation 135,000 135,000 Selling and administrative expenses 27,000 27,000 Total expenses 289,500 244,500 Pretax income 85,500 55,500 Income taxes (34%) 29,070 18,870 Net income $ 56,430 $ 36,630 TABLE B.1 Present Value of 1 Rate Perlods 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 12% 15% 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.8929 0.8696 0.9803 0.9612 0.9426 0.9246 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 0.7972 0.7561 0.9706 0.9423 0.9151 0.8890 0.8638 0.8396 08163 0.793 0.7722 753 7118 06575 0.9610 0.9238 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 0.6355 0.5718 0.9515 0.9057 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 0.5674 0.4972 0.9420 0.8880 0.8375 0.7903 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 0.5066 0.4323 0.9327 0.8706 0.8131 0.7599 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132 0.4523 0.3759 0.9235 0.8535 0.7894 0.7307 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 0.4039 0.3269 0.9143 0.8368 0.7664 0.7026 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 0.3606 0.2843 0.9053 0.8203 0.7441 0.6756 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 0.3220 0.2472 0.8963 0.8043 0.7224 0.6496 0.5847 0.5268 0.4751 0.4289 0.3875 0.3505 0.2875 0.2149 0.8874 0.7885 0.7014 0.6246 0.5568 0.4970 0.4440 0.3971 0.3555 0.3186 0.2567 0.1869 0.8787 0.7730 0.6810 0.6006 0.5303 0.4688 0.4150 0.3677 0.3262 0.2897 0.2292 0.1625 0.8700 0.7579 0.6611 0.5775 0.5051 0.4423 0.3878 0.3405 0.2992 0.2633 0.2046 0.1413 0.8613 0.7430 0.6419 0.5553 0.4810 0.4173 0.3624 0.3152 0.2745 0.2394 0.1827 0.1229 0.8528 0.7284 0.6232 0.5339 0.4581 0.3936 0.3387 0.2919 0.2519 0.2176 0.1631 0.1069 0.8444 0.7142 0.6050 0.5134 0.4363 0.3714 0.3166 0.2703 0.2311 0.1978 0.1456 0.0929 0.8360 0.7002 0.5874 0.4936 0.4155 0.3503 0.2959 0.2502 0.2120 0.1799 0.1300 0.0808 0.8277 0.6864 0.5703 0.4746 0.3957 0.3305 0.2765 0.2317 0.1945 0.1635 0.1161 0.0703 0.8195 0.6730 0.5537 0.4564 0.3769 0.3118 0.2584 0.2145 0.1784 0.1486 0.1037 0.0611 0.7798 0.6095 0.4776 0.3751 0.2953 0.2330 0.1842 0.1460 0.1160 0.0923 0.0588 0.0304 0.7419 0.5521 0.4120 0.3083 0.2314 0.174 0.1314 0.0994 0.0754 0.0573 0.0334 0.0151 0.7059 0.5000 0.3554 0.2534 0.1813 0.1301 0.0937 0.0676 0.0490 0.0356 0.0189 0.0075 0.6717 0.4529 0.3066 0.2083 0.1420 0.0972 0.0668 0.0460 0.0318 0.0221 0.0107 0.0037 4 9 10 12 13 14 15 16 18 19 20 25 30 35 40 * Used to compute the present value of a known future amount. For example: How much would you need to invest today at 10% compounded semiannually to accumulate $5,000 in 6 years from today? Using the factors of n = 12 and 5% (12 semiannual periods and a semiannual rate of 5%), the factor is 0.5568. You would need to invest S2,784 today ($5,000 × 0.5568).

Explanation / Answer

Answer to Part 1.

Project Y:
Depreciation Expense = (330,000 -0) / 6
Depreciation Expense = $55,000 per year

Annual Expected Cash Flow = Net Income + Depreciation
Annual Expected Cash Flow = $56,430 + $55,000
Annual Expected Cash Flow = $111,430

Project Z:
Depreciation Expense = (330,000 -0) / 5
Depreciation Expense = $66,000 per year

Annual Expected Cash Flow = Net Income + Depreciation
Annual Expected Cash Flow = $36,630 + $66,000
Annual Expected Cash Flow = $102,630

Answer to Part 2.

Project Y:
Payback period = Initial Investment / Annual Cash Flow
Payback period = 330,000 / 111,430
Payback period = 2.96 years

Project Z:
Payback period = Initial Investment / Annual Cash Flow
Payback period = 330,000 / 102,630
Payback period = 3.22 years

Answer to Part 3.

Project Y:
Accounting Rate of Return = Net Income / Average Investment * 100
Average Investment = (330,000 + 0) / 2 = $165,000
Accounting Rate of Return = 56,430 / 165,000 * 100
Accounting Rate of Return = 34.20%

Project Y:
Accounting Rate of Return = Net Income / Average Investment * 100
Average Investment = (330,000 + 0) / 2 = $165,000
Accounting Rate of Return = 36,630 / 165,000 * 100
Accounting Rate of Return = 22.20%

Answer to Part 4.

Project Y:
n = 6 years
i = 9%
Present Value of Cash Inflow= Expected Cash Flow * PV Factor
NPV = PV of Cash Inflow – PV of Cash Outflow
Present Value of Cash Inflow= 111,430 * 4.4859
Present Value of Cash Inflow= $499,863.84

Net present Value = $499,863.84 - $330,000
Net present Value = $169,863.84

Project Z:
n = 5 years
i = 9%
Present Value of Cash Inflow= Expected Cash Flow * PV Factor
NPV = PV of Cash Inflow – PV of Cash Outflow
Present Value of Cash Inflow= 102,630 * 3.8897
Present Value of Cash Inflow= $399,199.91

Net present Value = $399,199.91 - $330,000
Net present Value = $69,199.91

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