Managerial Accounting
Managerial Accounting
7th Edition
ISBN: 9781260247886
Author: Wild
Publisher: MCG
Question
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Chapter 11, Problem 2PSA

1.

To determine

To compute: Annual expected net cash flows.

1.

Expert Solution
Check Mark

Explanation of Solution

Given below is the table for the computation of annual expected net cash flows:

Annual cash flow
Particulars Project Y ($) Project Z ($)
Profit after tax 56,000 36,400
Depreciation 87,500 116,666.66
Cash flows after tax 143,500 153,066.66
Table(1)

Working notes:

Calculation of annual depreciation of Project Y,

    Annual depreciation= Investment in machinery Life of machinery = $350,000 4 years =$87,500

Calculation of annual depreciation of Project Z,

    Annual depreciation= Investment in machinery Life of machinery = $350,000 3 years =$116,666.66

Hence, cash flow after tax is from project Y is $143,500 and Project Z is $153,066.67

2.

To determine

To compute: Payback period.

2.

Expert Solution
Check Mark

Explanation of Solution

Computation of payback period for project Y:

Given,
Cost of investment of Project Y is $350,000.
Annual net cash flow from Project Y is $143,500.

Formula to calculate payback period,

    Payback period= Initial investment Net annual cash inflow

Substitute $350,000 for initial investment and $143,500 for net annual cash inflow.

    Payback period= $350,000 $143,500 =2.44 years

Computation of payback period for project Z:

Given,
Cost of investment of Project Z is $280,000.
Annual net cash flow from Project Z is $153,066.66.

Formula to calculate payback period,

    Payback period= Initial investment Net annual cash inflow

Substitute $280,000 for initial investment and $153,066.66 for net annual cash inflow.

    Payback period= $280,000 $153,066.66 =1.83 years

Hence, payback period of project Y is 2.44 years and Project Z is 1.83 years.

3.

To determine

To compute: Accounting rate of return (ARR).

3.

Expert Solution
Check Mark

Explanation of Solution

Computation of accounting rate of return (ARR) for Project Y:

Given,
Average annual profit of Project Y is $56,000.
Average investment in Project Y is $175,000.

Formula to calculate accounting rate of return,

    Accounting rate of return= Average annual profit Average investment

Substitute $56,000 for average annual profit and $175,000 for average investment.

    Accounting rate of return= $56,000 $175,000 =0.32 or 32%

Computation of accounting rate of return (ARR) for Project Z:

Given,
Average annual profit of Project Z is $36,400.
Average investment in Project Z is $140,000.

Formula to calculate of accounting rate of return,

    Accounting rate of return= Average annual profit Average investment

Substitute $56,000 for average annual profit and $175,000 for average investment.

    Accounting rate of return= $36,400 $140,000 =0.26 or 26%

Working notes:

Calculation of average investment of Project Y,

    Average investment= Opening investment+Closing investment 2 = $350,000+$0 2 =$175,000

Calculation of average investment of Project Z,

    Average investment= Opening investment+Closing investment 2 = $280,000+$0 2 =$140,000

Hence, ARR for Project Y is 32% and Project Z is 26%.

4.

To determine

To compute: Net present value.

4.

Expert Solution
Check Mark

Explanation of Solution

Computation of net present value (NPV) for Project Y:

Given,
Annual net cash flows from Project Y is $143,500
Cost of investment is $350,000.
Market interest rate is 8%.
Number of periods is 4 years.
Present value factor for cumulative 4 years is 3.31.

Formula to calculate NPV,

    NPV=Present value of cash flowsCost of investment

Substitute $457,290.20 for the present value of cash flows and $350,000 for the cost of investment.

    NPV=$457,290.20$350,000 =$107,290.20

Computation of Net present value (NPV) for Project Z:

Given,
Annual net cash flow from Project Z is $153,066.66.
Cost of investment is $280,000.
Market interest rate is 8%.
Number of periods is 3 years.
Present value factor for cumulative 3 years is 2.58.

Formula to calculate NPV,

    NPV=Present value of cash flowsCost of investment

Substitute $394,467.63 for the present value of cash flows and $280,000 for the cost of investment.

    NPV=$394,467.63$280,000 =$114,467.63

Working notes:

Calculation of present value of cash flows of Project Y,

    Present vale of cash flow=Annual net cash flow×PVIFA =$143,500×3.31 =$457,290.20

Calculation of present value of cash flows of Project Z,

    Present vale of cash flow=Annual net cash flow×PVIFA =$153,066.66×2.58 =$394,467.63

Hence, NPV for project Y is $125,290.20 and Project Z is $114,467.63.

5.

To determine

To identify: Recommendation to management to pursue Project Y.

5.

Expert Solution
Check Mark

Explanation of Solution

ul

  • It is recommended to management to pursue Project A since Project A has higher NPV, which is $125,290.20 as compared to Project Z, which is $114,467.63.
  • It is also to be noted that accounting rate of return of Project Y is higher, which is 32% as compared to Project Z, which is 26%.
  • Although Project Z has lower payback period, it is insufficient to make up for the extra year’s income from Project Y.
  • Hence, it is recommended to management to pursue Project Y.

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    Chapter 11 Solutions

    Managerial Accounting

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