CPT Company wants to by a new product machine. The machine will provide the comp

Question

CPT Company wants to by a new product machine. The machine will provide the company with a new product line: pressed food trays for kitchens. Two machines are being considered; the data for each machine follows: The company's minimum rate of return is 16 percent, and the maximum allowable payback period is 5 years. Compute the net present value for each machine. (Round to the nearest dollar.) Compute the profitability index for each machine. (Round to 2 decimal points.) Compute the accounting rate of return for each machine. (Round percentages to one decimal point, i.e. 13.1%.) Compute the payback for each machine. (Round to one decimal point.) From the Information generated in requirements 1, 2, 3, and 4, prepare a memo recommending which machine should be purchased.

Explanation / Answer

Solution 1: Net present value:

ETZ: NPV = ( Annual Cash Flow * PVIFA(16%,10) ) + (salvage value * PVIF(16%,10)) - Initial investment

NPV =( $64404 * 4.883 + $25000 * 0.227) - $350,000

= - $29840.26

LKR: NPV =( $75642 * 4.883 + $40000 * 0.227) - $370,000

= + $8439.88

Solution 2: Profitability Index:

ETZ: Profitability Index = Net Discounted cash flow / Initial Investment

= $320159.74 / $350000 = 0.91

LKR: Profitability Index = Net Discounted cash flow / Initial Investment

= $378440 / $370000 = 1.023

Solution 3: Accounting Rate of Return:

ETZ: ACC = Net Profit / Initial Investment = $39204 / $350,000 = 11.20%

LKR: ACC = Net Profit / Initial Investment = $48642 / $370,000 = 13.15%

Solution 4: Payback Period :

ETZ: Payback Period = Initial Investment / Annual Cash flow = $350,000 / $64404 = 5.43 years

LKR: Payback Period = Initial Investment / Annual Cash flow = $370,000 / $75642 = 4.89 years

Solution 5: Going through the results in first four solutions, our conclusion is

Machine LKR would be considered as per (1) Net Present Value of +$8440 (2) Profitability Index of 1.023 and (4) Payback period of 4.89 years, but LKR have a Accounting Rate of Return of 13.15% whereas the expected rate of return is 16% so it is negative from ARR point.

Machine ETZ would not be considered as per as per any solution. Moreover the maximum payback period is 5 years, whereas ETZ's Payback period is 5.43 years. So, ETZ is totally rejected.

Finally, Machine LKR would be considered for the new product line.

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