Factor Company is planning to add a new product to its line. To manufacture this

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 $499,000 cost with an expected four-year life and a $15,000 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. (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

Required:
1. Compute straight-line depreciation for each year of this new machine’s life.
2. 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.
5. Compute the net present value for this machine using a discount rate of 7% 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.)

Expected annual sales of new product $ 1,990,000 Expected annual costs of new product Direct materials 465,000 Direct labor 679,000 Overhead (excluding straight-line depreciation on new machine) 336,000 Selling and administrative expenses 154,000 Income taxes 32 % Required 1Required 2 Required 3 Required 4 Required 5 Compute straight-line depreciation for each year of this new machine's life Straight-line depreciation

Explanation / Answer

1. Calculation of annual depreciation of machine

Cost of machine = $499,000

Scrap value = $15,000

Useful life = 4 years

Annual depreciation = (Cost price - Scrap value)/Useful life

= (499,000 - 15,000)/4

= $121,000

2. Calculation of net income and net cash flow

Hence, annual net income = $159,800

Annual cash inflow = $280,800

3. Calculation of payback period

Payback period = Cost of machine/Annual cash inflow

= 499,000/280,800

= 1.77 years

4. Calculation of Accounting rate of return

Average investment = [1/2 x (Cost - scrap value)] + Scrap value

= [ 1/2 x (499,000 - 15,000)] + 15,000

= 242,000 + 15,000

= $257,000

Accounting rate of return = Annual profit after tax/Average Investment in the machine

= 159,800/257,000

= 62.18%

Sales 1,990,000 Less: Expenses: Direct materials - 465,000 Direct labor - 679,000 Overheads - 336,000 Selling and administrative overheads - 154,000 Depreciation - 121,000 Profit before tax 235,000 Less: Income tax - 75,200 Net income (Profit after tax) 159,800 Add: Deppreciation 121,000 Cash flows after tax 280,800

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