Zachary Electronics is considering investing in manufacturing equipment expected

Question

Zachary Electronics is considering investing in manufacturing equipment expected to cost $390,000. The equipment has an estimated useful life of four years and a salvage value of $ 23,000. It is expected to produce incremental cash revenues of $195,000 per year. Zachary has an effective income tax rate of 30 percent and a desired rate of return of 14 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)

a. Determine the net present value and the present value index of the investment, assuming that Zachary uses straight-line depreciation for financial and income tax reporting.

b. Determine the net present value and the present value index of the investment, assuming that Zachary uses double-declining-balance depreciation for financial and income tax reporting.

c. Determine the payback period and unadjusted rate of return (use average investment), assuming that Zachary uses straight-line depreciation.

d. Determine the payback period and unadjusted rate of return (use average investment), assuming that Zachary uses double-declining-balance depreciation. (Note: Use average annual cash flow when computing the payback period and average annual income when determining the unadjusted rate of return.)

TABLE 1 PRESENT VALUE OF $1 4% 5% 6% 1% 8% 9% 10% 12% 14% 16% 20% 1 0.961538 0.952381 0.943396 0.934579 0.925926 0.917431 0.909091 0.892857 0.877193 0.862069 0.833333 2 0.924556 0.907029 0.889996 0.873439 0.857339 0.841680 0.826446 0.797194 0.769468 0.743163 0.694444 3 0.888996 0.863838 0.839619 0.816298 0.793832 0.772183 0.751315 0.711780 0.674972 0.640658 0.578704 4 0.854804 0.822702 0.792094 0.762895 0.735030 0.708425 0.683013 0.635518 0.592080 0.552291 0.482253 5 0.821927 0.783526 0.747258 0.712986 0.680583 0.649931 0.620921 0.567427 0.519369 0.476113 0.401878 6 0.790315 0.746215 0.704961 0.666342 0.630170 0.596267 0.564474 0.506631 0.455587 0.410442 0.334898 7 0.759918 0.710681 0.665057 0.622750 0.583490 0.547034 0.513158 0.452349 0.399637 0.353830 0.279082 8 0.730690 0.676839 0.627412 0.582009 0.540269 0.501866 0.466507 0.403883 0.350559 0.305025 0.232568 9 0.702587 0.644609 0.591898 0.543934 0.500249 0.460428 0.424098 0.36061O 0.307508 0.262953 0.193807 10 0.675564 0.613913 0.558395 0.508349 0.463193 0.422411 0.385543 0.321973 0.269744 0.226684 0.161506 11 0.649581 0.584679 0.526788 0.475093 0.428883 0.387533 0.350494 0.287476 0.2366170.195417 0.134588 12 0.624597 0.556837 0.496969 0.444012 0.397114 0.355535 0.318631 0.256675 0.207559 0.168463 0.112157 13 0.600574 0.530321 0.468839 0.414964 0.367698 0.326179 0.289664 0.229174 0.182069 0.145227 0.093464 14 0.577475 0.505068 0.442301 0.387817 0.340461 0.299246 0.263331 0.204620 0.159710 0.125195 0.077887 15 0.555265 0.481017 0.417265 0.362446 0.315242 0.274538 0.239392 0.182696 0.140096 0.107927 0.064905 16 0.533908 0.458112 0.393646 0.338735 0.291890 0.251870 0.217629 0.163122 0.122892 0.093041 0.054088 17 0.513373 0.436297 0.371364 0.316574 0.270269 0.231073 0.197845 0.145644 0.107800 0.080207 0.045073 18 0.493628 0.415521 0.350344 0.295864 0.250249 0.211994 0.179859 0.130040 0.094561 0.069144 0.037561 19 0.474642 0.395734 0.330513 0.276508 0.231712 0.194490 0.163508 0.116107 0.082948 0.059607 0.031301 20 0.456387 0.376889 0.311805 0.258419 0.214548 0.178431 0.148644 0.103667 0.072762 0.051385 0.026084

Explanation / Answer

a) The table of cash flows using straight line depreciation

NPV = sum of discounted cash flows

= $1,02,480

Present value index = sum of discounted cash inflows / cash outflows

= 1.26

b) Table of cash flows using double declining method

NPV = $1,09,608

PI = 1.28

Working notes:

1) Depreciation

2) After tax salvage

c) Payback period

$2,89,100

payback period = 2.35 years

Unadjusted rate of return = average cash inflows / investment

= 169775 / 390000

= 43.53%

d) Payback period

Payback period = 2+(29250/151125)

= 2.19 years

Unadjusted rate of return = avergae inflows / avergae investment

= 169775 / 390000

= 43.53%

0 1 2 3 4 Incremental revenues $1,95,000 $1,95,000 $1,95,000 $1,95,000 Depreciation $97,500 $97,500 $97,500 $97,500 Operating income $97,500 $97,500 $97,500 $97,500 Tax@30% $29,250 $29,250 $29,250 $29,250 Net income $68,250 $68,250 $68,250 $68,250 Operating cash flows $1,65,750 $1,65,750 $1,65,750 $1,65,750 Initial investment -$3,90,000 After tax salvage value $16,100 Net cash flows -$3,90,000 $1,65,750 $1,65,750 $1,65,750 $1,81,850 Cost of capital $1 $0.877 $0.769 $0.675 $0.592 PV of cash flows -$3,90,000 $1,45,395 $1,27,539 $1,11,877 $1,07,670

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