Problem 3 Yummy Brands is considering the purchase of a new machine that dispens

Question

Problem 3 Yummy Brands is considering the purchase of a new machine that dispenses yogurt. The machine cost S500,000. Annual revenues and expenses associated with the new machine follow: Sales revenue $325,000 Operating Expenses: Operator salaries Ingredients cost Maintenance contract 30,000 60,000 32,000 20,000 40,000 You have been hired as Yummy Brands chief financial officer and you need to advise the company CEO if the company should invest in this machine. Show your analysis/ calculations in good form for all your A. In your meeting with the CEO you find out that the company usually does not like to invest unless if a project promises a payback period of 4 years or less. Should the company invest in this machine? Show your calculations in good form andexpain the pros and cons of this method to make this decision. Another approach that the CEO encouraged you to explore is the simple rate or return. Assuming that Yummy Brands requires a 15 percent on all equipment purchases, compute the simple rate of return promised by the new machine. Ignore income taxes. The CEO said he would be interested to find out about any other methods that should be used in this analysis. In the recent Yogurt Journal he had read something about using the intera rate of return of a particular investment in making an investment decision. As a recent graduate of managerial accounting you are expected to be familiar with this analysis and you should do the calculations and and make a recommendation based on this method B. C.

Explanation / Answer

1.

*

Payback period = Y + ( A / B ) where

Y = years before the payback year

A = Total cash flow remaining to be paid back at the start of the break-even year, for bringing cumulative cash flow to 0.

B = Total cash flow in the entire payback year

  

It will recover the investment in 1.78 years which is much less from target payback period of 4 years.hence, it should accept this.

Payback period is very easy to calculate and does not consider a noncash item like depreciation.however it has the limitation of not taking consideration of cash flow after the payback period.hence, it could accept a project which initially gives a higher return than any project but gives a low return in overall life.

Sales Revenue $      325,000 Operating Expenses: Advertising $     30,000 Operating salaries $     60,000 Ingreients Cost $     32,000 Maintenance Contract $     20,000 $      142,000 Cash flow $      183,000

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