Financial and Managerial Accounting (Looseleaf) (Custom Package)
Financial and Managerial Accounting (Looseleaf) (Custom Package)
6th Edition
ISBN: 9781259754883
Author: Wild
Publisher: MCG
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Chapter 24, Problem 2PSB

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:

Particulars Project A ($) Project B ($)
Net income ( A ) 39,900 25,900
Depreciation ( B ) 60,000 80,000
Net cash flows ( C )=( A )+( B ) 99,900 105,900
table(1)

Working note:

Calculation of annual depreciation of Project A,

    Annual depreciation= Investment in machinery Life of machinery = $240,000 4 years =$60,000

Calculation of annual depreciation of Project B,

    Annual depreciation= Investment in machinery Life of machinery = $240,000 3 years =$120,000

Hence, cash flow after tax is from project A is $99,900 and Project B is $105,900.

2.

To determine

To compute: Payback period.

2.

Expert Solution
Check Mark

Explanation of Solution

Computation of payback period for project A:

Given,
Cost of investment of Project A is $240,000.
Annual net cash flow from Project A is $99,900.

Formula to calculate payback period,

    Payback period= Initial investment Net annual cash inflow

Substitute $240,000 for initial investment and $99,900 for net annual cash inflow.

    Payback period= $240,000 $99,900 =2.40 years

Computation of payback period for project B:

Given,
Cost of investment of Project B is $240,000.
Annual net cash flow from Project B is $105,900.

Formula to calculate payback period,

    Payback period= Initial investment Net annual cash inflow

Substitute $240,000 for initial investment and $105,900 for net annual cash inflow.

    Payback period= $240,000 $105,900 =2.27 years

Hence, payback period of project A is 2.40 years and Project B is 2.27 years.

3.

To determine

To compute: Accounting rate of return.

3.

Expert Solution
Check Mark

Explanation of Solution

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

Given,
Average annual profit of Project A is $39,900.
Average investment in Project A is $120,000.

Formula to calculate of accounting rate of return,

    Accounting rate of return= Average annual profit Average investment

Substitute $39,900 for average annual profit and $120,000 for average investment.

    Accounting rate of return= $39,900 $120,000 =0.3325 or 33.25%

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

Given,
Average annual profit of Project B is $25,900.
Average investment in Project B is $120,000.

Formula to calculate of accounting rate of return,

    Accounting rate of return= Average annual profit Average investment

Substitute $25,900 for average annual profit and $120,000 for average investment.

    Accounting rate of return= $25,900 $120,000 =0.2158 or 21.58%

Working note:

Calculation of average investment of Project A,

    Average investment= Opening investment+Closing investment 2 = $240,000+$0 2 =$120,000

Calculation of average investment of Project B,

    Average investment= Opening investment+Closing investment 2 = $240,000+$0 2 =$120,000

Hence, ARR for project A is 33.25% and Project B is 21.58%.

4.

To determine

To compute: Net present value.

4.

Expert Solution
Check Mark

Explanation of Solution

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

Given,
Annual net cash flows from Project A is $199,900.
Cost of investment is $240,000.
Market interest rate is 8%.
Number of periods is 4 years.
Present value factor for cumulative 4 years is 3.3121.

Formula to calculate NPV,

    NPV=Present value of cash flowsCost of investment

Substitute $330,879 for the present value of cash flows and $240,000 for the cost of investment.

    NPV=$330,879$240,000 =$90,879

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

Given,
Annual net cash flow from Project B is $105,900.
Cost of investment is $240,000.
Market interest rate is 8%.
Number of periods is 3 years.
Present value factor for cumulative 3 years is 2.5771.

Formula to calculate NPV,

    NPV=Present value of cash flowsCost of investment

Substitute $272,915 for the present value of cash flows and $240,000 for the cost of investment.

    NPV=$272,915$240,000 =$32,915

Working notes:

Formula to calculate present value of cash flows of Project A,

    Present vale of cash flow=Annual net cash flow×PVIFA =$99,900×3.3121 =$330,879

Formula to calculate present value of cash flows of Project B,

    Present vale of cash flow=Annual net cash flow×PVIFA =$105,900×2.5771 =$272,915

Hence, NPV for project A is $90,879 and Project B is $32,915.

5.

To determine

To identify: Recommendation to management to pursue Project A.

5.

Expert Solution
Check Mark

Explanation of Solution

  • It is recommended to management to pursue Project A since Project A has higher NPV, which is $90,879 as compared to Project B, which is $32,915.
  • It is also to be noted that accounting rate of return of Project A is higher, which is 33.25% as compared to Project B, which is 21.58%.
  • Although Project B has lower Payback period, it is insufficient to make up for the extra year’s income from Project A.
  • Hence, it is recommended to management to pursue Project A.

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    Chapter 24 Solutions

    Financial and Managerial Accounting (Looseleaf) (Custom Package)

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