Yummy Brands is considering the purchase of a new machine that dispenses yogurt.
ID: 2486843 • Letter: Y
Question
Yummy Brands is considering the purchase of a new machine that dispenses yogurt. The machine cost$500,000. Annual revenues and expenses associated with the new machine follow:
Sales Revenue
$325,000
Operating Expenses:
Advertising
$30,000
Operator Salaries
$60,000
Ingredients Cost
$32,000
Maintenance Contract
$20,000
Depreciation
$40,000
You have been hired as Yummy Brands chief financial officer and you need to advise the company CEOif the company should invest in this machine. Show your analysis/ calculations in good form for all yourrecommendations:
A. In your meeting with the CEO you find out that the company usually does not like to invest unless ifa project promises a payback period of 4 years or less. Should the company invest in this machine?Show your calculations in good form and explain the pros and cons of this method to make this decision.
B. Another approach that the CEO encouraged you to explore is the simple rate or return. Assumingthat Yummy Brands requires a 15 percent on all equipment purchases, compute the simple rate ofreturn promised by the new machine. Ignore income taxes.
C. The CEO said he would be interested to find out about any other methods that should be used inthis analysis. In the recent Yogurt Journal he had read something about using the internal rate ofreturn of a particular investment in making an investment decision. As a recent graduate ofmanagerial accounting you are expected to be familiar with this analysis and you should do thecalculations and and make a recommendation based on this method
D. This is your first assignment to make a recommendation about a significant financial investmentand you want to be assured that you are making the correct recommendation. You are also tryingto impress your boss with your knowledge of managerial accounting. 1. Are there any othermethods that you would consider using in this particular situation? Explain the method(s) andshow your calculations/ analysis. Explain the pros and cons of all the methods that you have beenasked to consider or that you recommend.
Sales Revenue
$325,000
Operating Expenses:
Advertising
$30,000
Operator Salaries
$60,000
Ingredients Cost
$32,000
Maintenance Contract
$20,000
Depreciation
$40,000
Explanation / Answer
Ans 1 Pay Back period=Investment/Annual cash inflow 500000/183000 2.73 years Annual Cash flow (depreciation not deducted) 325000-30000-60000-32000-20000 183000 Yes the company can invest it it as it has payback period of 2.73 years which is less than 4 years. Pros This method is easy to calculate and used in in tial screening of alternatives It measures the risk which is inherent in the project Cons It does not used discounted value of cash so does not take time value of money in consideration and does not take cash flow after the payback period Ans 2 Simple rate of Return=accounting profit/ Investment *100 143000/500000*100 28.6 % Accounting Profit 325000-30000-60000-32000-20000-40000 143000 It is 28.6 more than 15% so should be accepted Ans 3 IRR Investment 500000 Depreciation 40000 No. of years comimg as 12.5 So lets assume there is salvage value 20000 So now useful life of asset(500000-20000)/40000 12 years Annula cash Flows 183000 PVIFA(36%,12) 2.7084 PV of annula cash Flows 495637.2 Salavge Value 20000 PVIF(36%,12) 0.025 PV Salavage value 500 Total PV of cash inflows 496137.2 Less: initial Investment 500000 NPV -3862.8 IRR is where NPV is 0 Annula cash Flows 183000 PVIFA(35.7%,12) 2.7293 PV of annula cash Flows 499461.9 Salavge Value 20000 PVIF(35.7%,12) 0.0256 PV Salavage value 512 Total PV of cash inflows 499973.9 Less: initial Investment 500000 NPV -26.1 Almost near to 0 IRR= 35.7% So should be accepted as exceeds required rate of return Ans 4 Yes it Is NPV NPV calcultes the Nert present value of the project at required rate of return. This is one of the best method as it takes into consideration the discounted cash flows Annula cash Flows 183000 PVIFA(15%,12) 5.4206 PV of annula cash Flows 991969.8 Salavge Value 20000 PVIF(15%,12) 0.1869 PV Salavage value 3738 Total PV of cash inflows 995707.8 Less: initial Investment 500000 NPV 495707.8 It should be accepted
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