Smile Photo, Inc, is a nationally franchised company with over 50 outlets locked

Question

Smile Photo, Inc, is a nationally franchised company with over 50 outlets locked in the southern states. Part of the franchise agreement promises a centralized photo developing process with overnight delivery to the outlets. Because of the tremendous increase in demand for its photo processing. Emma DuBarry, the corporations president, is considering the purchase of a new, deluxe photo processing machine by the end of this month. DuBarry wants you to formulate a memo showing your evaluation of this purchase. Your memo will be presented at the board of directors' meeting next week. According to your research, the new machine will cost $320,000. It will function for an estimated five years and should have a $32,000 residual value. All capital investments are expected to produce a 20 percent minimum rate of return, and the investment should be recovered in three years or less. All fixed assets are depredated using the straight-line method. The forecasted increases in operating results for the new machine are as follows: 1. In preparation for writing your memo, answer the following questions: a. What kinds of information do you need to prepare this memo? b. Why is the information relevant? c. Where would you find the information? d. When would you want to obtain the information? 2. Analyze the purchase of the machine and decide if the company should purchase it. Use (a) the net present value method, (b) the accounting rate-of-return method, and (c) the payback period method. 3. What is the profitability index of the project? 4. What is the IRR of the project?

Explanation / Answer

2. The depreciation is calculated as follows:

Inital Value = 320,000, Residual value = 32,000

So Depreciable value = 320,000 - 32,000 = 288,000

So depreciation per year = 288,000/5 = 57,600

2.a.The NPV is calulated as follows: (Since depreciation is a non- cash expense, it is not included in the analysis)

2.b. The accounting rate of return is calculated as follows:

Average Accounting Income: (42400 + 47400 + 52400 + 32400- + 54400)/5 = 45800

Inital investment = 320,000

So Accounting rate of return = Average accoubnting Income/ Inital Investment = 45800/320,000 = 14.31%

2(c) Payback period

Payback period = 3 + 5000/90000 = 3.056 years

3. Profitabiltiy Index

= 1+ NPV/Initial Investment = 1 -11,679.53/320000 = 0.9635

4.IRR is calculated as follows:

IRR = 18.34%

Year 0 1 2 3 4 5 Initial Investment -320000 Cash inflow 310000 325000 340000 300000 260000 Cash outflow -210000 -220000 -230000 -210000 -180000 Salavge Value 32000 Net Cash flow -320000 100000 105000 110000 90000 112000 NPV at 20% $   -11,679.53

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