Chapter 25 Problem Everest Company has the opportunity to invest in one of two p
ID: 2803184 • Letter: C
Question
Chapter 25 Problem Everest Company has the opportunity to invest in one of two projects: Project A requires $300,000 investment for new machinery with a 4-year life and no salvage value. Project B requires $300,000 investment for new machinery with a 3-year life and no salvage value. . The company uses straight-line depreciation, and cash flows occur evenly throughout each year. The predicted annual results are as follows: Project AProject B S 230,000 S 300,000 Sales Expenses: Direct materials Direct Labor 41,000 60,000 Overhead including depreciation106,000 20,000 227,000 73,000 25,000 35,000 106,000 20,000 186,000 44,000 Selling and administrative exp Total expenses Pretax income eo Required: Calculate the following: 1. Compute each project's annual expected net cash flow.Explanation / Answer
Answer 1.
Project A:
Cost of Machine = $300,000
Useful Life = 4 years
Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $300,000 / 4
Annual Depreciation = $75,000
Annual Net Cash flows = Pretax Income + Depreciation
Annual Net Cash flows = $73,000 + $75,000
Annual Net Cash flows = $148,000
Project B:
Cost of Machine = $300,000
Useful Life = 3 years
Annual Depreciation = Cost of Machine / Useful Life
Annual Depreciation = $300,000 / 3
Annual Depreciation = $100,000
Annual Net Cash flows = Pretax Income + Depreciation
Annual Net Cash flows = $44,000 + $100,000
Annual Net Cash flows = $144,000
Answer 2.
Project A:
Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $300,000 / $148,000
Payback Period = 2.03 years
Project B:
Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $300,000 / $144,000
Payback Period = 2.08 years
Answer 3.
Project A:
Initial Investment = $300,000
Average Investment = $300,000 / 2
Average Investment = $150,000
Average Rate of Return = Pretax Income / Average Investment
Average Rate of Return = $73,000 / $150,000
Average Rate of Return = 48.67%
Project A:
Initial Investment = $300,000
Average Investment = $300,000 / 2
Average Investment = $150,000
Average Rate of Return = Pretax Income / Average Investment
Average Rate of Return = $44,000 / $150,000
Average Rate of Return = 29.33%
Answer 4.
Project A:
Initial Investment = $300,000
Annual Net Cash flows = $148,000
Net Present Value = -$300,000 + $148,000 * PVIFA (8%, 4)
Net Present Value = -$300,000 + $148,000 * 3.3121
Net Present Value = $190,190.80
Project A:
Initial Investment = $300,000
Annual Net Cash flows = $144,000
Net Present Value = -$300,000 + $144,000 * PVIFA (8%, 3)
Net Present Value = -$300,000 + $144,000 * 2.5771
Net Present Value = $71,102.40
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