Kenneth Gould is the general manager at a small-town newspaper that is part of a

Question

Kenneth Gould is the general manager at a small-town newspaper that is part of a national media chain. He is seeking approval from corporate headquarters (HQ) to spend $20,000 to buy some Macintosh computers and a laser printer to use in designing the layout of his daily paper. This equipment will be depreciated using the straight line method over four years. These computers will replace outmoded equipment that will be kept on hand for emergency use.
HQ requires Kenneth to estimate the cash flows associated with the purchase of new equipment over a 4-year horizon. The impact of the project on net income is derived by subtracting depreciation from cash flow each year. The project

Explanation / Answer

Part a)

The contribution to net income is derived by subtracting the value of depreciation from the annual cost savings projected. The formula that can be derived is:

Contribution to Net Income = Cost Savings - Depreciation

Depreciation = Cost/Estimate Life

___________________

Depreciation = 20,000/4 = $5,100

Contribution Statement

Average Net Income = (2,500 + 4,100 + 4,100 + 4,100)/4 = $3,700

____________________

Part b)

The formula for calculating average book value of the investment is:

Average Book Value of the Investment = (Beginning Investment Value + Ending Investment Value)/2

___________________

Here, Beginning Investment Value= $20,000 and Ending Investment Value 0 (since the asset is completely depreciated)

Using these values in the above formula, we get,

Average Book Value of the Investment = ($20,000 + 0)/2 = $10,000

____________________

Part c)

Average accounting rate of return will be calculated with the use of average income (part a) and average book value of the investment (part b). The formula for calculating average accounting rate of return is:

Average Accounting Rate of Return = Average Net Income/Average Investment*100

___________________

Using the values calculated in part a and part b in the above formula, we get,

Average Accounting Rate of Return = 3,700/10,000*100 = 37%

____________________

Part d)

Payback period is the period within the investment made by the company is completely recovered with the use of cash flows expected from the project.

___________________

Here, the investment is $20,000. It will be recovered as follows:

Year 1 Cash Flow = $7,500

Year 2 Cash Flow = $9,100

and the balance of $3,400 ($20,000 - $7,500 - $9,100) between Year 2 and Year 3

___________________

Payback Period = Years Upto which Partial Recovery is Made + Balance Amount/Cash Flow of the Year in which Full Recovery is Made = 2 + 3,400/9,100 = 2.37 or 2.4 Years

Year 1 Year 2 Year 3 Year 4 Cost Savings 7,500 9,100 9,100 9,100 Less Depreciation 5,000 5,000 5,000 5,000 Contribution to Net Income $2,500 $4,100 $4,100 $4,100

Related Questions

Navigate

• Browse (All)
• Browse K
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.