Timpani Company wants to buy a machine to be used in producing parts for sale to

Question

Timpani Company wants to buy a machine to be used in producing parts for sale to companies that manufacture industrial equipment. The cost of the machine will be $3,500,000. The equipment will last live years with a $200,000 expected salvage value. The expected cash flows from the machine are provided below. The company uses the straight line method to depreciate its assets. The company has an average tax rate of 30%. Management of the company will not invest in any project unless they can cam an after tax rate of return of 10% and the project must pay back its initial investment after taxes in 3.25 years or less. Calculate the after tax accounting rate of return on average investment for this machine. Round your percentage answer to two decimal places (four decimal places in all). Show supporting calculations. Calculate the after tax payback period for this machine. Round your answer to two decimal places. Show supporting calculations. Calculate the after tax net present value for this machine. Round your answer to the nearest whole dollar. Show supporting calculations. Should the company purchase the machine? Provide an adequate explanation for your answer.

Explanation / Answer

We need to determine the net income (PAT) and operating cash flows to answer all the parts of the question.

________

Part A)

The after tax accounting return is calculated as follows:

After-Tax Accounting Return = [(Sum of PAT of All Years)/Number of Years]/Initial Investment = [(238000 - 42000 + 238000 + 98000 + 28000)(5)]/(3500000) = 3.20%

________

Part B)

Payback period is the period within which initial investment is recovered by the company. The initial investment for this project will get recovered as follows:

Cash Flow Year 1 = 898,000, Cash Flow Year 2 = 618,000, Cash Flow Year 3 = 898,000, Cash Flow Year 4 = $758,000 and the balance of $328,000 between Year 4 and Year 5.

The payback period can be calculated with the use of following formula:

Payback Period = Year upto which Partial Recovery is Made + Balance/Cash Flow of the Year in which Full Recovery is Made = 4 + 328,000/828,000= 4.40 Years

________

Part C)

NPV is the difference between the present value of cash inflows and cash outflows. It is calculated with the use of following formula:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Rate of Return)^1 + Cash Flow Year 2/(1+Rate of Return)^2 + Cash Flow Year 3/(1+Rate of Return)^3 + Cash Flow Year 4/(1+Rate of Return)^4 + Cash Flow Year 5/(1+Rate of Return)^5

Using the values calculated in the table, we get,

NPV = -3,500,000 + 898,000/(1+10%)^1 + 618,000/(1+10%)^2 + 898,000/(1+10%)^3 + 758,000/(1+10%)^4 + 828,000/(1+10%)^5 = -$466,364.82 or -$466,365

________

Part D)

No, the machine should not be purchased as it has a payback period of more than 3.25 years (the period acceptable by the company) and provides a negative NPV.

0 1 2 3 4 5 Initial Cost -3,500,000 Cash Revenues 0 3,500,000 3,750,000 4,000,000 4,000,000 3,500,000 Less Cash Expenses 0 2,500,000 3,150,000 3,000,000 3,200,000 2,800,000 Less Depreciation ((3,500,000-200,000/5)) 0 660,000 660,000 660,000 660,000 660,000 Profit Before Taxes 0 340,000 -60,000 340,000 140,000 40,000 Tax 102,000 -18,000 102,000 42,000 12,000 Profit After Taxes 238,000 -42,000 238,000 98,000 28,000 Add Depreciation 660,000 660,000 660,000 660,000 660,000 Salvage Value (200,000*(1-30%)) 0 0 0 0 140,000 Operating Cash Flow $898,000 $618,000 $898,000 $758,000 $828,000

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

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