1.
Ascertain the
1.
Explanation of Solution
Net present value method (NVP): Net present value method is the method which is used to compare the initial
Compute the net present value of company P as follows:
Year | After-TaxCash Flow (5) (a) | Discount Factor (b) | Present value |
20x0 | $(956,600) | 1.000 | $(956,600) |
20x1 | $310,987 | .893 | 277,711 |
20x2 | $353,688 | .797 | 281,889 |
20x3 | $248,270 | .712 | 176,768 |
20x4 | $232,454 | .636 | 147,841 |
20x5 | $211,200 | .567 | $119,750 |
Net present value | $47,359 |
Table (1)
Corporation O should purchase the new equipment to manufacture waste containers.
Note: Refer Appendix A (table III) for the discount factor.
Working notes (1):
Compute the manufacturing savings per unit cost:
Particulars | Amounts in ($) | Amounts in ($) |
Unit purchase cost | $27.00 | |
New unit variable | ||
Material | $8.00 | |
Direct labor | 7.50 | |
Variable overhead | 4.50 | 20.00 |
Savings per unit | $ 7.00 |
Table (2)
Working notes (2):
Compute the manufacturing savings:
Year | Unit Savings (1) | Estimated Production | Estimated Cost | (1 – Tax Rate) | After-Tax Cost Savings | ||||
20x1 | $7 | 50,000 | $350,000 | 0.6 | $210,000 | ||||
20x2 | 7 | 50,000 | 350,000 | 0.6 | 210,000 | ||||
20x3 | 7 | 52,000 | 364,000 | 0.6 | 218,400 | ||||
20x4 | 7 | 55,000 | 385,000 | 0.6 | 231,000 | ||||
20x5 | 7 | 55,000 | 385,000 | 0.6 | 231,000 |
Table (3)
Working notes (3):
Compute the installed cost of depreciation:
Particulars | Amounts in ($) |
Acquisition cost | $945,000 |
Less: Discount | (18,900 |
Add: Freight | 11,000 |
Installation | 22,900 |
Net installed cost | $960,000 |
Table (4)
Working notes (4):
Compute the MACRS depreciation tax shield:
Year | Installed Cost (3) | MACRS Rate | Depreciation | Tax rate | Tax benefit |
(a) | (b) | (d) | |||
20x1 | $960,000 | 33.33% | $319,968 | 0.4 | $127,987 |
20x2 | 960,000 | 44.45% | 426,720 | 0.4 | 170,688 |
20x3 | 960,000 | 14.81% | 142,176 | 0.4 | 56,870 |
20x4 | 960,000 | 7.41% | 71,136 | 0.4 | 28,454 |
Table (4)
Working notes (5):
Compute the MACRS depreciation tax shield:
Particulars | 20x0 | 20x1 | 20x2 | 20x3 | 20x4 | 20x5 |
Equipment cost | $(945,000) | |||||
Discount (3) | 18,900 | |||||
Freight | (11,000) | |||||
Installation cost | (22,900) | |||||
Savage value for—old equipment | 900 | |||||
Working capital reduction | 2,500 | |||||
Manufacturing savings (2) | $210,000 | $210,000 | $218,400 | $231,000 | $231,000 | |
Supervision | (27,000 | (27,000 | (27,000 | (27,000 | (27,000 | |
Depreciation tax shield (4) | 1,27,987 | 1,70,688 | 56,870 | 28,454 | - | |
Salvage value for new equipment | 7,200 | |||||
After-tax cash flow | $(956,600) | $310,987 | $353,688 | $248,270 | $232,454 | $211,200 |
Table (5)
2.
State the reason for the computation of the payback period of an investment in addition to the determination of net present value.
2.
Explanation of Solution
Since the payback method provides a preliminary screening of projects, many companies prefer computing the payback method, along with the calculation of net present value. Moreover, it indicates the manner in which an original investment can be recovered speedily from the cash flows, when a project is considered risky.
3.
Identify the consecutive whole number amounts in which the payback period for the new equipment is computed.
3.
Explanation of Solution
Payback period: Payback period is the expected time period which is required to recover the cost of investment. It is one of the capital investment method used by the management to evaluate the proposal of long-term investment (fixed assets) of the business. But payback method has high risk than other method, because it does not follow the time value of money concept in valuing the cash inflows.
Compute the payback period for the new equipment:
The payback period is between 3 and 4 years. Because the initial net installed cost is $956,600 and the after tax cash flow for 20x3 year is $912,945
Want to see more full solutions like this?
Chapter 16 Solutions
Managerial Accounting: Creating Value in a Dynamic Business Environment
- Mallette Manufacturing, Inc., produces washing machines, dryers, and dishwashers. Because of increasing competition, Mallette is considering investing in an automated manufacturing system. Since competition is most keen for dishwashers, the production process for this line has been selected for initial evaluation. The automated system for the dishwasher line would replace an existing system (purchased one year ago for 6 million). Although the existing system will be fully depreciated in nine years, it is expected to last another 10 years. The automated system would also have a useful life of 10 years. The existing system is capable of producing 100,000 dishwashers per year. Sales and production data using the existing system are provided by the Accounting Department: All cash expenses with the exception of depreciation, which is 6 per unit. The existing equipment is being depreciated using straight-line with no salvage value considered. The automated system will cost 34 million to purchase, plus an estimated 20 million in software and implementation. (Assume that all investment outlays occur at the beginning of the first year.) If the automated equipment is purchased, the old equipment can be sold for 3 million. The automated system will require fewer parts for production and will produce with less waste. Because of this, the direct material cost per unit will be reduced by 25 percent. Automation will also require fewer support activities, and as a consequence, volume-related overhead will be reduced by 4 per unit and direct fixed overhead (other than depreciation) by 17 per unit. Direct labor is reduced by 60 percent. Assume, for simplicity, that the new investment will be depreciated on a pure straight-line basis for tax purposes with no salvage value. Ignore the half-life convention. The firms cost of capital is 12 percent, but management chooses to use 20 percent as the required rate of return for evaluation of investments. The combined federal and state tax rate is 40 percent. Required: 1. Compute the net present value for the old system and the automated system. Which system would the company choose? 2. Repeat the net present value analysis of Requirement 1, using 12 percent as the discount rate. 3. Upon seeing the projected sales for the old system, the marketing manager commented: Sales of 100,000 units per year cannot be maintained in the current competitive environment for more than one year unless we buy the automated system. The automated system will allow us to compete on the basis of quality and lead time. If we keep the old system, our sales will drop by 10,000 units per year. Repeat the net present value analysis, using this new information and a 12 percent discount rate. 4. An industrial engineer for Mallette noticed that salvage value for the automated equipment had not been included in the analysis. He estimated that the equipment could be sold for 4 million at the end of 10 years. He also estimated that the equipment of the old system would have no salvage value at the end of 10 years. Repeat the net present value analysis using this information, the information in Requirement 3, and a 12 percent discount rate. 5. Given the outcomes of the previous four requirements, comment on the importance of providing accurate inputs for assessing investments in automated manufacturing systems.arrow_forwardBasuras Waste Disposal Company has a long-term contract with several large cities to collect garbage and trash from residential customers. To facilitate the collection, Basuras places a large plastic container with each household. Because of wear and tear, growth, and other factors, Basuras places about 200,000 new containers each year (about 20% of the total households). Several years ago, Basuras decided to manufacture its own containers as a cost-saving measure. A strategically located plant involved in this type of manufacturing was acquired. To help ensure cost efficiency, a standard cost system was installed in the plant. The following standards have been established for the products variable inputs: During the first week in January, Basuras had the following actual results: The purchasing agent located a new source of slightly higher-quality plastic, and this material was used during the first week in January. Also, a new manufacturing process was implemented on a trial basis. The new process required a slightly higher level of skilled labor. The higher- quality material has no effect on labor utilization. However, the new manufacturing process was expected to reduce materials usage by 0.25 pound per container. Required: 1. CONCEPTUAL CONNECTION Compute the materials price and usage variances. Assume that the 0.25 pound per container reduction of materials occurred as expected and that the remaining effects are all attributable to the higher-quality material. Would you recommend that the purchasing agent continue to buy this quality, or should the usual quality be purchased? Assume that the quality of the end product is not affected significantly. 2. CONCEPTUAL CONNECTION Compute the labor rate and efficiency variances. Assuming that the labor variances are attributable to the new manufacturing process, should it be continued or discontinued? In answering, consider the new processs materials reduction effect as well. Explain. 3. CONCEPTUAL CONNECTION Refer to Requirement 2. Suppose that the industrial engineer argued that the new process should not be evaluated after only one week. His reasoning was that it would take at least a week for the workers to become efficient with the new approach. Suppose that the production is the same the second week and that the actual labor hours were 9,000 and the labor cost was 99,000. Should the new process be adopted? Assume the variances are attributable to the new process. Assuming production of 6,000 units per week, what would be the projected annual savings? (Include the materials reduction effect.)arrow_forwardAn oil refinery finds that it is necessary to treat the waste liquids from a new process before discharging them into a stream. In-house treatment will have an annual cost of $20,000 the first year, but process improvements will allow the annual cost to decline by $2,000 each subsequent year. As an alternative, an outside company will process the wastes for an initial cost of $10,500 and an annual fixed price of $8,500/year throughout the 11 year period. Either way, there is no need to treat the wastes after 11 years. Using the AW method, calculate the equivalent uniform annual cost (EUAC) of each alternative and determine how the waste should be processed. The company's MARR is 12%. Click the icon to view the interest and annuity table for discrete compounding when the MARR is 12% per year. The EUAC for in-house treatment is $ positive cash flow.) The EUAC for outside treatment is S positive cash flow.) The most economical alternative is O A. outside treatment B. in-house treatment…arrow_forward
- Philadelphia Fastener Corporation manufactures nails, screws, bolts, and other fasteners. Management is considering a proposal to acquire new material-handling equipment. The new equipment has the same capacity as the current equipment but will provide operating efficiencies in labor and power usage. The savings in operating costs are estimated at $150,000 annually.The new equipment will cost $300,000 and will be purchased at the beginning of the year when the project is started. The equipment dealer is certain that the equipment will be operational during the second quarter of the year it is installed. Therefore, 60 percent of the estimated annual savings can be obtained in the first year. The company will incur a one-time expense of $30,000 to transfer production activities from the old equipment to the new equipment. No loss of sales will occur, however, because the processing facility is large enough to install the new equipment without interfering with the operations of the…arrow_forwardA grocery distribution center is considering whether to invest in RFID or bar code technology to track its inventory within the warehouse and truck loading operations. The useful life of the RFID and bar code devices is projected to be 5 years with minimal or zero salvage value. The bar code investment cost is $105,000 and can be expected to save at least $33,000 in product theft and lost items annually. The RFID system is estimated to cost $230,000 and will save $30,000 the first year, with an increase of $15,000 annually after the first year. For a 6% MARR, should the manager invest in the RFID system or the bar code system? Analyze incrementally using rate of return.arrow_forwardJackson Inc. disposes of other companies’ toxic waste. Currently, Jackson loads the waste by handinto a truck, which requires labor of $20 per load. Jackson is considering a machine that wouldreduce the amount of time needed to load the waste. The machine would cost $200,000 but wouldreduce labor cost to $5 per load. Assume that Jackson averages 10,000 loads per year. How manyyears (rounded to 2 decimal places) would it take for Jackson to recover the cost of the new machine?arrow_forward
- Johnson Limited is contemplating the installation of a new system that would allow for automated handling of customer inquiries about their order status, account balances, etc. Currently all such inquiries are handled manually by customer service representatives. The software for the new system would cost $214,000. An additional $169,000 would be required for one-time installation costs. Management estimates that the new system would result in costs of $10,300 per year related to addressing software issues and other technological problems that may arise. However, the new system is expected to reduce labour costs by $65,000 per year. Management estimates that the system would be used for five years. Severance costs related to the employees that would be laid off after implementing the new system would be $22,600. Johnson Limited requires a return of at least 15% on investments of this type. Required: Ignore income taxes. 1. Compute the net annual cost savings promised by the new system.…arrow_forwardKingsville plans to buy a street-cleaning machine. A used cleaning vehicle will cost $80,000 and have a $10,000 salvage value at the end of its five year life. A new system with advanced features will cost $160,000 and have a $45,000 salvage value at the end of its five year life. The new system is expected to reduce labor hours compared with the used system. Current street cleaning activity requires the used system to operate 8 hours per day for 20 days per month. Labor costs $50 per hour and MARR is 12% per year. Find the breakeven labor hours for the new system. USE SOLVER FUNCTION IN EXCELarrow_forwardA small company that manufactures vibration isolation platforms is trying to decide whether it should immediately upgrade the current assemblysystem D, which is rather labor-intensive, with the more highly automated system C one year from now. Some components of the current system canbe sold now for $9000, but they will be worthless hereafter. The operating cost of the existing system is $192,000 per year. System C will cost $320,000 with a $50,000 salvage value after four years. Its operating cost will be $68,000 per year. If you are told to do a replacement analysis using an interest rate of 10% per year, which system do you recommend?arrow_forward
- Difend Cleaners has been considering the purchase of an industrial dry-cleaning machine. The existing machine is operable for three more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $170,000. The new machine will cost $360,000 and an additional cash investment in working capital of $170,000 will be required. The new machine will reduce the average amount of time required to wash clothing and will decrease labor costs. The investment is expected to net $130,000 in additional cash inflows during the first year of acquisition and $290,000 each additional year of use. The new machine has a three-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life. What is the net present value of the investment, assuming the required rate of…arrow_forwardA consulting engineer is considering two methods for lining landfill for municipal solid waste management in Bannock County, Idaho. A geosynthetic bentonite clay liner (GCL) will cost $2.0 million to install, and if it is renovated after 4 years at a cost of $400,000, its life can be extended another 2 years. Alternatively, a high-density polyethylene (HDPE) geomembrane can be installed that will have a useful life of 12 years. At an interest rate of 6% per year, how much money can be spent on the HDPE liner for the two methods to break even?arrow_forwardA process control manager is considering two robots to improve materials-handling capacity in the production of rigid shaft couplings that make dissimilar drive components. Robot X has a first cost of $74,000, an annual M&O cost of $31,000, and $35,000 salvage value, and it will improve revenues by $96,000 per year. Robot Y has a first cost of $146,000, an annual M&O cost of $28,000, and $47,000 salvage value, and it will increase revenues by $120,000 per year. The company's MARR is 10% per year, and it uses a 3-year study period for economic evaluations. Calculate the incremental ROR, and identify the robot the manager should select. The incremental ROR is %. The manager should select robot (Click to select) ♥arrow_forward
- Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage LearningManagerial Accounting: The Cornerstone of Busines...AccountingISBN:9781337115773Author:Maryanne M. Mowen, Don R. Hansen, Dan L. HeitgerPublisher:Cengage Learning