Concept explainers
1.
Calculate the
1.
Explanation of Solution
Net present value method (NVP): Net present value method is the method which is used to compare the initial
Calculate the net present value of the machine replacement for Company T as follows:
Year |
(M) | Present value factor @12% (N) |
Present value |
20x2 | $313,320 | 0.893 | $ 279,795 |
20x3 | $357,800 | 0.797 | $ 285,167 |
20x4 | $239,240 | 0.712 | $ 170,339 |
20x5 | $209,640 | 0.636 | $ 133,331 |
Total present value | $ 868,632 | ||
Less: Cash outflow for investment (4) | $ 964,000 | ||
Net present value of machine | ($ 95,368) |
Table (1)
Note: Refer Appendix A (table III) for the present value factor.
Working note (1):
Calculate the depreciation expense of the machine under MACRS.
Depreciation Schedule | ||||
Year |
MACRS Percentage (A) |
Depreciation |
Tax Rate (C) |
Depreciation Tax Shield |
20x2 | 33.33% | $ 333,300 | 40% | $133,320 |
20x3 | 44.45% | $444,500 | 40% | $177,800 |
20x4 | 14.81% | $148,100 | 40% | $59,240 |
20x5 | 7.41% | $74,100 | 40% | $29,640 |
Table (2)
Working note (2):
Calculate the after tax annual operating cost saving.
Working note (3):
Calculate the salvage value of old machine.
Working note (4):
Calculate the net cash outflow of machine.
Working note (5):
Calculate the net cash inflow of machine.
Year | After tax operating cost savings (2) (C) |
Depreciation expense (1) (D) |
Incremental Profit |
20x2 | $180,000 | $133,320 | $313,320 |
20x3 | $180,000 | $177,800 | $357,800 |
20x4 | $180,000 | $59,240 | $239,240 |
20x5 | $180,000 | $29,640 | $209,640 |
Table (3)
2.
Calculate the
2.
Explanation of Solution
Internal
Calculate the internal rate of return on the machine replacement as follows:
Year |
Total After-Tax Cash Flow (5) (G) | Present value factor at 6% discount rate (H) |
Present Value under 6% discount rate | Present value factor at 8% discount rate (I) |
Present Value under 8% discount rate |
20x1 | -$ 964,000 | 1.000 | $-964,000 | 1.000 | $-964,000 |
20x2 | $ 313,320 | 0.943 | 295,461 | 0.926 | 290,134 |
20x3 | $ 357,800 | 0.890 | 318,442 | 0.857 | 306,635 |
20x4 | $ 239,240 | 0.840 | 200,962 | 0.794 | 189,957 |
20x5 | $ 209,640 | 0.792 | 166,035 | 0.735 | 154,085 |
Net present value | $ 16,900 | -$ 23,189 |
Table (4)
The internal rate of return of machine replacement is between 6% and 8%, because the net present value is positive under 6% discount rate but the net present value is negative when 8% discount rate is used.
3.
Identify the consecutive whole number amounts in which the payback period for the machine replacement is computed.
3.
Explanation of Solution
Identify the consecutive whole number amounts in which the payback period for the machine replacement is computed as follows:
Initial net cash outflow = $964,000.
Year | After tax cash inflow | Accumulated cash flow |
20x2 | $ 313,320 | $ 313,320 |
20x3 | $ 357,800 | $671,120 |
20x4 | $ 239,240 |
$910,360 |
20x5 | $ 209,640 |
$1,120,000 |
Table (5)
The initial net cash outflow of the investment falls between $910,360 and $1,120,000. Hence the two whole number of payback period is 3 years (20x4) and 4 years (20x5).
4.
Calculate the salvage of value of new machine on December 31, 20x5 if machine replacement is considered as an acceptable investment.
4.
Explanation of Solution
Calculate the salvage of value of new machine on December 31, 20x5 if machine replacement is considered as an acceptable investment as follows:
The net present value of machine is ($95,368) with zero salvage value. Before the discount factor, the salvage value of old machinery would be $149,950
Note: X denotes the salvage value of new machinery.
Therefore, the salvage value of new machine must exceed $249,917 in order to consider the machine replacement is an acceptable investment.
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Chapter 16 Solutions
Managerial Accounting: Creating Value in a Dynamic Business Environment
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