Crichton Publications uses the accounting rate of return method to evaluate prop
ID: 2489860 • Letter: C
Question
Crichton Publications uses the accounting rate of return method to evaluate proposed capital investments. The company’s desired rate of return is 18%. The project being evaluated involves a new product that will have a three-year life. The investment required is $300,000, which consists of a $240,000 machine, and inventories and accounts receivable totaling $60,000. The machine will have a useful life of three years and a salvage value of $150,000. The salvage value will be received during the fourth year, and the inventories and accounts receivable related to the product also will be converted back to cash in the fourth year. Accrual accounting net income from the product will be $87,000 per year, before depreciation expense, for each of the three years. Because of the time lag between selling the product and collecting the accounts receivable, cash flows from the product will be: Table 6-4 (Use appropriate factor(s) from the tables provided. Round the PV factors to 4 decimals.)
1st year
$
42,000
2nd year
72,000
3rd year
87,000
4th year
60,000
Calculate the accounting rate of return for the first year of the product. Assume straight-line depreciation. (Round your answer to the nearest whole dollar amount.)
Calculate the net present value of the product using a discount rate of 18% and assuming that cash flows occur at the end of the respective years. (Round your answer to the nearest whole dollar amount.)
1st year
$
42,000
2nd year
72,000
3rd year
87,000
4th year
60,000
Calculate the accounting rate of return for the first year of the product. Assume straight-line depreciation. (Round your answer to the nearest whole dollar amount.)
Calculate the net present value of the product using a discount rate of 18% and assuming that cash flows occur at the end of the respective years. (Round your answer to the nearest whole dollar amount.)
Explanation / Answer
Annual Rate of return = Profit after tax/Initial capital invested
Annual Acounting income before Dpreciation = $87000
Annual Depreciation = ($240000 - 150000)/3 = 30000
Profit After Tax = $87000-$30000 = $57000
Accountin Rate of return = $57000/300000 = 0.19 or 19%
Calculation of NPV
Time PVF Amount P.V Cash Out flow Cost of machine 0 1 240000 240000 Working capital 0 1 60000 60000 Present value of cash outflows - (A) 300000 Cash inflows Cash flows 1 0.847 42000 35574 2 0.718 72000 51696 3 0.609 87000 52983 4 0.516 60000 30960 Release of working capital 4 0.516 60000 30960 Salvage value of Machine 4 0.516 150000 77400 Present value of cash inlows - (B) 279573 NPV (B - A) (20427)Related Questions
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