Exercises
Exercise A Diane Manufacturing Company is considering investing USD 600,000 in new equipment with an estimated useful life of 10 years and no salvage value. The equipment is expected to produce USD 240,000 in cash inflows and USD 160,000 in cash outflows annually. The company uses straight-line depreciation, and has a 40 per cent tax rate. Determine the annual estimated net income and net cash inflow.
Exercise B Zen Manufacturing Company is considering replacing a four-year-old machine with a new, advanced model. The old machine was purchased for USD 60,000, has an estimated useful life of 10 years with no salvage value, and has annual maintenance costs of USD 15,000. The new machine would cost USD 45,000, but annual maintenance costs would be only USD 6,000. The new machine would have an estimated useful life of 10 years with no salvage value. Using straight-line depreciation and an assumed 40 per cent tax rate, compute the additional annual cash inflow if the old machine is replaced.
Exercise C Given the following annual costs, compute the payback period for the new machine if its initial cost is USD 420,000.
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Old machine
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New machine
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Depreciation
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$ 18,000
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$ 42,000
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Labor
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72,000
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63,000
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Repairs
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21,000
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4,500
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Other costs
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12,000
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3,600
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$ 123,000
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$ 113,100
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Exercise D Jefferson Company is considering investing USD 33,000 in a new machine. The machine is expected to last five years and to have a salvage value of USD 8,000. Annual before-tax net cash inflow from the machine is expected to be USD 7,000. Calculate the unadjusted rate of return. The income tax rate is 40 per cent
Exercise E Compute the profitability index for each of the following two proposals assuming the desired minimum rate of return is 20 per cent. Based on the profitability indexes, which proposal is better?
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Initial cash outlay
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Proposal 1
$ 16,000
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Proposal 2
$ 10,300
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Net cash inflow (after taxes):
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First year
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10,000
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6,000
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Second year
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9,000
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6,000
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Third year
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6,000
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4,000
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Fourth year
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-0-
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2,500
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Exercise F Ross Company is considering three alternative investment proposals. Using the following information, rank the proposals in order of desirability using the payback period method.
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A
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B
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C
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Initial outlay
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$ 360,000
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$ 360,000
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$ 360,000
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Net cash inflow (after taxes):
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|
|
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First year
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$ -0-
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$ 90,000
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$ 90,000
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Second year
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180,000
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270,000
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180,000
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Third year
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180,000
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90,000
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270,000
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Fourth year
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90,000
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180,000
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450,000
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$ 450,000
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$ 630,000
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$ 990,000
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Exercise G Simone Company is considering the purchase of a new machine costing USD 50,000. It is expected to save USD 9,000 cash per year for 10 years, has an estimated useful life of 10 years, and no salvage value. Management will not make any investment unless at least an 18 per cent rate of return can be earned. Using the net present value method, determine if the proposal is acceptable. Assume all tax effects are included in these numbers.
Exercise H Refer to the data in previous exercise. Calculate the time-adjusted rate of return.
Exercise I Rank the following investments for Renate Company in order of their desirability using the (a) payback period method, (b) net present value method, and (c) time-adjusted rate of return method. Management requires a minimum rate of return of 14 per cent.
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Investmen t
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Initial
Cash outlay
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Expected after-tax net cash
Inflow per year
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Expected life of proposal
(years)
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A
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$ 120,000
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$ 15,000
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8
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B
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150,000
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26,000
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20
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C
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240,000
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48,000
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10
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