Everest Company has the opportunity to invest in one of two projects: • Project
ID: 2486917 • Letter: E
Question
Everest Company has the opportunity to invest in one of two projects: • Project A requires $500,000 investment for new machinery with a 4-year life and no salvage value. • Project B requires $500,000 investment for new machinery with a 3-year life and no salvage value. The company uses straight-line depreciation, and cash flows occur evenly throughout each year. The predicted annual results are as follows: Project A Project B Sales $ 500,000 $ 530,000 Expenses: Direct materials 41,000 25,000 Direct Labor 60,000 35,000 Overhead including depreciation 306,000 306,000 Selling and administrative exp 20,000 20,000 Total expenses 427,000 386,000 Pretax income 73,000 44,000 Income taxes (30%) 21,900 13,200 Net Income $ 51,100 $ 30,800 Required: Calculate the following: 1. Compute each project’s annual expected net cash flow. 2. Determine each project’s payback period. 3. Compute each project’s average rate of return. 4. Determine each project’s net present value using 8% as the discount rate. (assume that cash flows occur at year-end).
Explanation / Answer
Project A
Project B
Sales
500000
530000
Less- Expenses
Direct materials
41000
25000
Direct labor
60000
35000
Overhead including depreciation
306000
306000
Selling and administrative exp
20000
20000
Total expenses
427000
386000
Pre tax income
73000
44000
Less- income taxes
21900
13200
Net income
51100
30800
Add- depreciation
125000
166666.7
Cash Inflow
176100
197466.7
project’s annual expected net cash flow
176100
197466.7
Payback period = cost of investment / net cash inflow
= 500000/ 176100
= 2.84
=500000/197466.7
= 2.53
Project A
Project B
Project’s annual expected net cash Inflow
176100
197466.7
Cumulative Present value factor @8%
3.312
2.577
Present value of cash inflow
583243.2
508871.7
Less- Present value of cash outflow
500000
500000
Net Present value
83243.2
8871.686
Project A
Project B
Sales
500000
530000
Less- Expenses
Direct materials
41000
25000
Direct labor
60000
35000
Overhead including depreciation
306000
306000
Selling and administrative exp
20000
20000
Total expenses
427000
386000
Pre tax income
73000
44000
Less- income taxes
21900
13200
Net income
51100
30800
Add- depreciation
125000
166666.7
Cash Inflow
176100
197466.7
project’s annual expected net cash flow
176100
197466.7
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