Bookstore wants to buy a new coding machine to help control book inventories. Th

Question

Bookstore wants to buy a new coding machine to help control book inventories. The machine sells for $30,000 and requires working capital of $4,000. Its estimated useful life is 4 years and it has an estimated salvage value of $5,000. The working capital will also be recovered at the end of the machine’s useful life. The Company expects to save $11,000 in operating costs per year by purchasing this machine. The Company uses straight-line depreciation. Note: all computations are pretax except 4 below.

Required:

Compute the net present value and internal rate of return (using excel) of the machine at a 14% rate of return.

Compute the payback period of the investment.

Compute the pretax accrual accounting rate of return, based on the initial investment.

Compute the after tax accrual accounting rate of return. The Company’s tax rate is 40%.

Run two scenarios that vary inputs that you think the Company should consider. Compute the NPV and IRR for these scenarios. Note: You cannot change the rate of return.

Should the company buy this machine? Why or why not? What other business considerations would you want to point out to the company?

Set up your Excel spreadsheet with 4 tabs

·       Input and conclusion (Inputs and 5 above)

·       Net present value and IRR (1) above

·       Payback (2) above

·       Accrual accounting rates of return (3 and 4 above)

·       Scenarios (5 above)

Explanation / Answer

a) Initial Investment = 30000+4000 = $ 34000

Annual Cash Flows

Amount in $

Discounted @ 14%

Year 1

11000

9649

Year 2

11000

8464

Year 3

11000

7425

Year 4

20000

11842

Sum of Discounted Cash Flows

37380

4th Year Cash Flow will be calculated as follows-

Saving in Operating Cost + Salvage + Working Capital recovered

NPV = $ 37380 - $ 34000 = $ 3380

IRR Calculation-

Annual Cash Flows

Amount in $

Discounted @ 14%

Discounted @ 18%

Discounted @ 19%

Year 1

11000

9649

9322.034

9243.697

Year 2

11000

8464

7900.029

7767.813

Year 3

11000

7425

6694.94

6527.574

Year 4

20000

11842

10315.78

9973.375

Sum of Discounted Cash Flows

37380

34232.78

33512.46

Using Extrapolation -

34232.78-34000 = 232.78 = 0.323 + 18% , So IRR = 18.32%

34232.78-33512.46 720.32

b) Pay Back Period-

Formula for above is- Payback period = Initial Investment/Annual Cash flow

Annual Cash Flow for 1st 3 Years = 33000

Fourth year part = 1000/20000 = 0.05

Therefore, Payback Period is 3 + 0.05 = 3.05 Years

C) Pretax Accounting Rate of Return -

Sum of Cash Flows without discounting - $ 53000

Initial Investment - $ 34000

Pre Tax income for 4 Years - $ 19000

Yearly Income - $ 19000/4 = $ 4750

Yearly Accounting Rate of Return = $4750/$34000= 13.97%

d) Post Tax Accounting Rate of Return-

Annual Cash Flows

Amount in $

After Tax

Tax benefit of Depreciation

Total Post Tax Benefit

Year 1

11000

6600

2500

9100

Year 2

11000

6600

2500

9100

Year 3

11000

6600

2500

9100

Year 4

11000

6600

2500

9100+4000+5000

Total

45400

Net Savings in 4 Years = 45400 - 34000 = $ 11400 , that is $ 2850 per year

So, Post Tax Accounting Rate of Return will be $2850/$34000 = 8.38%

Annual Cash Flows

Amount in $

Discounted @ 14%

Year 1

11000

9649

Year 2

11000

8464

Year 3

11000

7425

Year 4

20000

11842

Sum of Discounted Cash Flows

37380

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.