Chapter 11 Problems
I. Payback period computation; even cash flows
Compute the payback period for each of the following two separate investments (round the payback period to two decimals):
1. A new operating system for an existing machine is expected to cost $260,000 and have a useful life of five years. The system yields an incremental after-tax income of $75,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10,000.
Payback period =Cost of investment/ Annual net cash flow
=$260,000/ $125,000
=2.08 years
Annual depreciation = $260,000 -$10,000 / 5 = $50,000
Annual after tax income $75,000
+ Depreciation 50,000
Annual net cash flow $125,000
2. A machine costs $190,000, has a $10,000 salvage value, is expected to last nine years, and will generate an after-tax income of $30,000 per year after straight-line depreciation.
Payback period =Cost of investment/ Annual net cash flow
=$190,000/ $50,000
=3.8 years
Annual depreciation = $190,000 -$10,000 / 9 = $20,000
Annual after tax income $30,000
+ Depreciation 20,000
Annual net cash flow $50,000
II. Payback period computation; uneven cash flows
Wenro Company is considering the purchase of an asset for $90,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year. Compute the payback period for this investment.
Part of year = Amount paid back in year 4/ Net cash flows in year 4 = $10,000 / $60,000 = 0.167
Payback period =3 + 0.167 = 3.1367 years = 3yrs 2 mos.
III. Accounting Rate of Return
A machine costs $500,000 and is expected to yield an after-tax net income of $15,000 each year. Management predicts this machine has a 10-year service life and a $100,000 salvage value, and it uses straight-line depreciation. Compute this machine’s accounting rate of return.
Average investment =$500,000 + $100,000 / 2 = $300,000
Accounting rate of return
Compute the payback period for each of the following two separate investments (round the payback period to two decimals):
1. A new operating system for an existing machine is expected to cost $260,000 and have a useful life of five years. The system yields an incremental after-tax income of $75,000 each year after deducting its straight-line depreciation. The predicted salvage value of the system is $10,000.
Payback period =Cost of investment/ Annual net cash flow
=$260,000/ $125,000
=2.08 years
Annual depreciation = $260,000 -$10,000 / 5 = $50,000
Annual after tax income $75,000
+ Depreciation 50,000
Annual net cash flow $125,000
2. A machine costs $190,000, has a $10,000 salvage value, is expected to last nine years, and will generate an after-tax income of $30,000 per year after straight-line depreciation.
Payback period =Cost of investment/ Annual net cash flow
=$190,000/ $50,000
=3.8 years
Annual depreciation = $190,000 -$10,000 / 9 = $20,000
Annual after tax income $30,000
+ Depreciation 20,000
Annual net cash flow $50,000
II. Payback period computation; uneven cash flows
Wenro Company is considering the purchase of an asset for $90,000. It is expected to produce the following net cash flows. The cash flows occur evenly throughout each year. Compute the payback period for this investment.
Part of year = Amount paid back in year 4/ Net cash flows in year 4 = $10,000 / $60,000 = 0.167
Payback period =3 + 0.167 = 3.1367 years = 3yrs 2 mos.
III. Accounting Rate of Return
A machine costs $500,000 and is expected to yield an after-tax net income of $15,000 each year. Management predicts this machine has a 10-year service life and a $100,000 salvage value, and it uses straight-line depreciation. Compute this machine’s accounting rate of return.
Average investment =$500,000 + $100,000 / 2 = $300,000
Accounting rate of return