From the Franklin Lumber Case 21 ( Capital Budgeting Procedures ) Q1 - Calculate

Question

From the Franklin Lumber Case 21 ( Capital Budgeting Procedures )

Q1 - Calculate the annual cash flows of the Dakola (the Nakoi's cash flow is 265,820 per year , not including its after - tax terminal value)

Q2- Calculate the Dakota's :

a- Payback period

b- Average accounting rate of return (AARR)

c- IRR

Q3- Rank the plywood presses by the five techniques listed in question 2

Q4- Do the techniques rank the projects the same ? If not , why do the rankings differ ?

Q5- Parker's two primary capital budgeting methods are the payback and the average accounting rate of return.

a- What are the disadvantages of the payback ? What , if any, are its advantages?

b- What are the disadvantages of the AARR ? What , if any , are it's advantages?

Explanation / Answer

Answer: Output per day = 6000 7000 sqft Days in a year = 240 240 Market price per sqft = $1.80 $1.80 Raw material = 70% 70% Annual Labour cost = $276,000 $245,000 Maintenance cost = $52,000 $60,000 Annual overhead = $78,000 $60,000 Salvage value = $75,000 $390,000 Answer-1 For dakota Year 0 1 2 3 4 5 6 7 Machine cost ($1,300,000) Salvege value $390,000 Revenues $3,024,000.00 $3,024,000.00 $3,024,000.00 $3,024,000.00 $3,024,000.00 $3,024,000.00 $3,024,000.00 Cost of raw material $2,116,800.00 $2,116,800.00 $2,116,800.00 $2,116,800.00 $2,116,800.00 $2,116,800.00 $2,116,800.00 labour cost $245,000 $245,000 $245,000 $245,000 $245,000 $245,000 $245,000 maintenance cost $60,000 $60,000 $60,000 $60,000 $60,000 $60,000 $60,000 overhead $60,000 $60,000 $60,000 $60,000 $60,000 $60,000 $60,000 Depreciation 185714.2857 185714.2857 185714.2857 185714.2857 185714.2857 185714.2857 185714.2857 Net profit $356,485.71 $356,485.71 $356,485.71 $356,485.71 $356,485.71 $356,485.71 $356,485.71 Tax (40%) $142,594.29 $142,594.29 $142,594.29 $142,594.29 $142,594.29 $142,594.29 $142,594.29 Profit after tax $213,891.43 $213,891.43 $213,891.43 $213,891.43 $213,891.43 $213,891.43 $213,891.43 Cash flow ($1,300,000) $399,605.71 $399,605.71 $399,605.71 $399,605.71 $399,605.71 $399,605.71 $789,605.71 Answer-2 Payback period Cumulative cash flow 0 -1300000 1 399605.7143 399605.7143 2 399605.7143 799211.4286 3 399605.7143 1198817.143 4 399605.7143 1598422.857 5 399605.7143 1998028.571 6 399605.7143 2397634.286 7 $789,605.71 3187240 so the pay back period = 3.253 ARR = average profit / average investment = 13.47% IRR = 26.27% NPV = $                    509,142.95 Profitability Index = 1.391648419 Answer-3 Criteria Nakoi Dakota Rank-Nakoi Rank-Dakota Payback 2.8 3.253 1 2 ARR 42.30% 13.47% 1 2 IRR 30.40% 26.27% 1 2 NPV $384,000 $                509,142.95 2 1 PI 1.52 1.39 1 2 Overall Nakoi is a better option. Answer-4 The difference exists in the ranking. The reason is the difference in the timing of the cash flow of both the projects. Answer-5 a. The disadvantage of payback period is that it doe not take the time value of money into account. b. The disadvantage of the ARR is also the same that it does not incorporate time value of money criteria into account.

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