Required information Problem 25-2A Analysis and computation of payback period, a

Question

Required information Problem 25-2A Analysis and computation of payback period, accounting rate of return, and net present value LO P1, P2, P3 [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 $330,000 investment for new machinery with a six-year life and no salvage value. Project Z requires a $330,000 investment for new machinery with a five-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. (PV of $1. FV of $1, PVA of $1, and FVA of $1 (Use appropriate factor(s) from the tables provided.) Project Y Project Z $365,000 $292,000 Sales Expenses Direct materials Direct labor Overhead including depreciation Selling and administrative expenses 51,100 73,000 36,500 43,800 131,400 131,400 26,000 237,706 54,300 18,462 $ 55,110 35,838 Total expenses Pretax income Income taxes (34%) Net income 26,000 281, 500 83,500 28,390

Explanation / Answer

Answer to Part 1.

Project Y:
Depreciation Expense = (330,000 -0) / 6
Depreciation Expense = $55,000 per year

Annual Expected Cash Flow = Net Income + Depreciation
Annual Expected Cash Flow = $55,110 + $55,000
Annual Expected Cash Flow = $110,110

Project Z:
Depreciation Expense = (330,000 -0) / 5
Depreciation Expense = $66,000 per year

Annual Expected Cash Flow = Net Income + Depreciation
Annual Expected Cash Flow = $35,838 + $66,000
Annual Expected Cash Flow = $101,838

Answer to Part 2.

Project Y:
Payback period = Initial Investment / Annual Cash Flow
Payback period = 330,000 / 110,110
Payback period = 3.00 years

Project Z:
Payback period = Initial Investment / Annual Cash Flow
Payback period = 330,000 / 101,838
Payback period = 3.24 years

Answer to Part 3.

Project Y:
Accounting Rate of Return = Net Income / Average Investment * 100
Average Investment = (330,000 + 0) / 2 = $165,000
Accounting Rate of Return = 55,110 / 165,000 * 100
Accounting Rate of Return = 33.40%

Project Z:
Accounting Rate of Return = Net Income / Average Investment * 100
Average Investment = (330,000 + 0) / 2 = $165,000
Accounting Rate of Return = 35,838 / 165,000 * 100
Accounting Rate of Return = 21.72%

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