Laurel Company has an opportunity to invest in two projects. Project Y requires
ID: 2452524 • Letter: L
Question
Laurel Company has an opportunity to invest in two projects. Project Y requires a $350,000 investment for new machinery with a four-year life and no salvage value. Project Z requires a $350,000 investment for new machinery with a three-year life and no salvage value. The projects yield the following predicted annual results. The Company uses a straight line depreciation, and cash flow occur evenly throughout each year.
Project Y Project Z
sales 350,000 350,000
Expenses
Direct Material 49,000 35,000
Direct Labor 70,000 42,000
Overhead including depreciation 126,000 126,000
Selling and admin expenses 25,000 25,000
________ ________
Total Expe 270,000 228,000
_________ ________
Pre-tax income 80,000 52,000
Income taxex 30% 24,000 15.600
______ _______
Net income 56,000 36,400
1) Compute each project's annual expected net cash flows (round to the nearest dollar)
2) Determine each project's payback period
3) Compute each project accounting rate of return
4) Determine each project net present value using 8% as the discount rate. For part 4 only, assume that the cash flow occur at each year-end
5) identify the project to recomend and why.
Explanation / Answer
As per question, the Company uses a straight line depreciation, and cash flow occur evenly throughout each year. So, Annual Depreciation charged per year (included in Overheads) to the results are:
Project Y = $350000/4years = $ 87500 per year
Project Z = $350000/3 years = $ 116667 per year
The Projects projected annual results are:
Amount in $
(1) Each project's annual expected net cash flows (round to the nearest dollar) are:
Project Y = $ 143500
Project Z = $ 153067
(2) Each Project's payback period are:
Project Y = $ 350000 / $ 143500 = 2.44 years
Project Z = $ 350000 / $ 153067 = 2.29 years
(3) Each Project's accounting rate of return, where we do not consider the future value of money, are:
Project Y = $56000 / $ 350000 = 16%
Project Z = $36400 / $ 350000 = 10.4%
(4) Each Project Net Present Value using 8% as the discount rate are :
Project Y:
Project Z:
(5) Laurel Company is recommended to choice Project Y because (a) as its Net Present Value is higher at $ 124924, (b) its payback period is around the payback period of Project Z and (c) its Accounting rate of return is higher at 16% than Project Z.
Particulars Project Y Project Z Project New Machinery Cost 350000 350000 Sales 350000 280000 Expenses: Direct Material 49000 35000 Direct Labour 70000 42000 Overhead included Depreciation 126000 126000 Selling and admin expenses 25000 25000 Total Expenses 270000 228000 Pre-tax income 80000 52000 Income tax @ 30% 24000 15600 Net income (A) 56000 36400 Depreciation ( as calculated above) (B) 87500 116667 Cash Flow ( A + B) per year 143500 153067 Project Pay Back Period ( in years or part) 2.44 2.29 Project accounting rate of return 16% 10.4%Related Questions
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