5. Capital budgeting Flynn Corporation is debating whether to purchase a new com

Question

5. Capital budgeting

Flynn Corporation is debating whether to purchase a new computerized production system. The system will cost $450,000, and have an estimated 10-year life with a salvage value of $70,000. The estimated operating results from the new production system are as follows:

Incremental Revenue $180,000

Incremental Expenses

Expenses other than depreciation $85000

Depreciation (Straight line basis) $38000 $123,000

Incremental Net Income $57,0000

All revenue and expenses other than depreciation will be received and paid in cash. Compute the following for this proposal

: (a) Annual net cash flow: $__________

(b) Payback period: __________ years

(c) Return on average investment: __________%

(d) Net present value, discounted at an annual rate of 6% (present value of $1 due in 10 years, discounted at 6%, is 0.558; present value of $1 received annually for 10 years, discounted at 6%, is 7.360): $__________

Explanation / Answer

Req A. Annual cash inflows Net incremental income 57,000 Add: Depreciation expense 38000 Annual cash inflows 95,000 Req B: Initial investment: 450,000 Annual Cash inflows:   95,000 Payback period = Initial investment/ Annual cash inflows ( 450,000 /95,000 ) = 4.74 years ReqC: Return on Average investment = Net incremental income/ Average investment Average investment = Cost of Assets /2 = 450,000 /2 = 225,000 Returnon average Investment = 57,000 /225,000 *100 = 25.33% ReqD: Net present value Present value of cash inflows annually ($ 95,000with Annuity factor of 10 years i.e. 7.360) 699200 Add: Present value of salvage value of investment at the end of 10th yearr(70,000 *0.558) 39060 Total present value of cash inflows 738260 Less: Present value of cash outflows 450000 Net present value 288260

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