[The following information applies to the questions displayed below,] Most Compa

Question

[The following information applies to the questions displayed below,] Most Company has an opportunity to invest in one of two new projects. Project Y requires a $335,000 investment for new machinery with a five-year life and no salvage value. Project Z requires a $335,000 investment for new machinery with a four-year life and no salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation, and cash flows occur evenly throughout each year. (FV of $1, PV of $1, FVA of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.) Project Y Project Z $355,000 284,000 Sales Expenses Direct materials Direct labor Overhead including depreciation Selling and administrative expenses 49,700 71,000 127,800 25,000 35,500 42,600 127,800 25,000 Total expenses 273,500 230,900 Pretax income Income taxes (28%) 81,500 22,820 53,100 14,868 Net income $ 58,680 38,232 Required 1. Compute each project's annual expected net cash flows Project Y Project Z

Explanation / Answer

Net income = revenue - all cash and non- cash expenses

But for get the 'Cash Flow' we need to add back the non-cash expenses to the net income (after tax).in this case it is depreciation.depreciation is a non-cash expense company does't have any cash outflow for the depreciation expense.so it should add back to the net income and also helps to get a tax reduction. Because of this feature depreciation also known as "Tax shield".

1)

PROJECT Y   

Project's annual expected net cash flow = net income + depreciation

*)net income =58680

*)depreciation = 335000÷5 = 67000

Net cash flow = 58680+67000 = 125680 per year (for 5 years)

PROJECT Z

Annual expected net cash flow = Net income + depreciation

*)net income = 38232

*)depreciation = 335000 ÷ 4 = 83750

Net cash flow = 83750+38232 = 121982 per year. (for four years)

2)

Payback period = initial investment ÷ annual expected net cash flow

PROJECT Y

*)Annual expected net cash flow =125680

*)Initial investment = 335000

Payback period = 335000 ÷ 125680=2.66 or 2.66 years

PROJECT Z

*)initial investment = 335000

*)net cash flow = 121982

payback period = 335000 ÷ 121982 = 2.75

( from payback period analysis we can conclude that PROJECT Y is better than PROJECT Z because Y have small payback period.)

3)

PROJECT Y

Present value = 9% annuity factor for five years × annual cash flow

9% annuity factor = 3.88

annual cash flow =125680

present value = 3.88 × 125680 = 488895

*)Net present value (NPV) = present value of future cashflow - initial investment

present value of cashflow =487638

initial investment = 335000

NPV = 488895-335000 = 153895

PROJECT Z

Present value = 9% annuity factor for four years × net cash flow

9% annuity factor = 3.24

net cash flow =121982

present value =3.24 ×121982 =395222

NPV = Present value - initial investment

present value =395222

initial investment = 335000

NPV =395222-335000 = 60222

"Annuity factor rounded (Approx)"

(With respect to NPV results PROJECT Y is more favourable than PROJECT Z.)

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