1.
Prepare a schedule for expected
1.
Explanation of Solution
Net cash flow: Net cash flow is the difference between cash receipts and cash payments.
Year |
Operating costs after tax (A)(1) | Savings (4) (B) |
Net | |
0 | $(630,000) | |||
1 | ($31,500) | $218,700 | $18,000 | $205,200 |
2 | ($31,500) | $218,700 | $36,000 | $223,200 |
3 | ($31,500) | $218,700 | $36,000 | $223,200 |
4 | ($31,500) | $218,700 | $36,000 | $223,200 |
5 | ($31,500) | $218,700 | $36,000 | $223,200 |
6 | ($31,500) | $218,700 | $36,000 | $223,200 |
7 | ($31,500) | $218,700 | $36,000 | $223,200 |
8 | ($31,500) | $218,700 | $18,000 | $205,200 |
9 | ($31,500) | $218,700 | - | $187,200 |
10 | ($31,500) | $218,700 | - | $187,200 |
Table (1)
Working note (1):
Calculate the annual operating cost after tax:
Working note (2):
Calculate the annual depreciation expense.
Working note (3):
Calculate the annual depreciation expense after tax:
Year | Annual deprecation (A) (2) | Deprecation after tax |
1 | 45,000 | $18,000 |
2 | 90,000 | $36,000 |
3 | 90,000 | $36,000 |
4 | 90,000 | $36,000 |
5 | 90,000 | $36,000 |
6 | 90,000 | $36,000 |
7 | 90,000 | $36,000 |
8 | 45,000 | $18,000 |
Table (2)
Note: The annual depreciation expense is $90,000; however the depreciation expense is calculated on the basis of straight line deprecation with half year convention method. Hence, the depreciation expense under half year convention method is $45,000
Working note (4):
Calculate the annual savings after tax:
2.
Calculate the payback period of company H.
2.
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.
Calculate the payback period of company H as follows:
Initial investment = $630,000.
Year | Cash inflow | Accumulated cash flow |
1 | $205,200 | $205,200 |
2 | $223,200 | $428,400 |
3 | $223,200 | $651,600 |
4 | $223,200 | $874,800 |
5 | $223,200 | $1,098,000 |
6 | $223,200 | $1,321,200 |
7 | $223,200 | $1,544,400 |
8 | $205,200 | $1,749,600 |
9 | $187,200 | $1,936,800 |
10 | $187,200 | $2,124,000 |
Table (3)
In this case, the initial investment of $630,000 falls between $428,400 and $651,600. Hence, the payback period is calculated as follows:
Therefore, the payback period for the given investment is 2.90 years.
3.
Ascertain the
3.
Explanation of Solution
Ascertain the Net present value of the closed-loop system and describe whether the company should invest in the system:
Year | Cash inflow | Present value factor @10% | Present value |
1 | $205,200 | 0.862 | $ 176,882 |
2 | $223,200 | 0.743 | $ 165,838 |
3 | $223,200 | 0.641 | $ 143,071 |
4 | $223,200 | 0.552 | $ 123,206 |
5 | $223,200 | 0.476 | $ 106,243 |
6 | $223,200 | 0.410 | $ 91,512 |
7 | $223,200 | 0.354 | $ 79,013 |
8 | $205,200 | 0.305 | $ 62,586 |
9 | $187,200 | 0.263 | $ 49,234 |
10 | $187,200 | 0.227 | $ 42,494 |
Total present value | $ 1,040,080 | ||
Less: | $ 630,000 | ||
Net present value | $ 410,080 |
Table (4)
The company should invest in the system because the net present value is positive.
4.
State the effect that the inclusion of after tax would have on the payback period and on the net present value.
4.
Explanation of Solution
State the effect that the inclusion of after tax would have on the payback period and on the net present value:
Payback period:
In this case, the annual cash flows increase by $135,000. Therefore the cash inflow for year 1 would increase to $340,200
Initial investment = $630,000.
Year | Cash inflow | Accumulated cash flow |
1 | $340,200 | $340,200 |
2 | $358,200 | $698,400 |
3 | $358,200 | $1,056,600 |
4 | $358,200 | $1,414,800 |
5 | $358,200 | $1,773,000 |
6 | $358,200 | $2,131,200 |
7 | $358,200 | $2,489,400 |
Table (5)
In this case, the initial investment of $630,000 falls between $340,200 and $698,400. Hence, the payback period is calculated as follows:
Therefore, the payback period for the given investment is reduced by 1.81 years
Net present value:
Particulars | Amounts in ($) | Amounts in ($) |
Fines and sales (a) | $135,000 | |
NPV for 10 years (b) | $4.833 | |
Fines and sales effect | $652,455 | |
Lawsuit avoidance | $300,000 | |
NPV for 3 years | $0.641 | |
Add: Lawsuit avoidance | $192,300 | |
Total NPV | $844,755 |
Table (6)
Therefore, the net present value is increased by $434,676
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Chapter 19 Solutions
Cornerstones of Cost Management (Cornerstones Series)
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