Chapter 24: Problem Set A

Problem 24-1A: New Machine Investment Analysis 1. Determine Annual Income and Net Cash Flow: o Calculate the annual depreciation using the straight-line method: Depreciation=Cost−Salvage ValueLife=480,000−20,0004=115,000 o Annual Net Cash Flow: Add back depreciation to net income (since it's a non-cash expense). 2. Compute Payback Period: o Formula: Payback Period=Initial InvestmentAnnual Net Cash Flow 3. Compute NPV: o Discount each annual net cash flow at a 7% discount rate and subtract the initial investment. o Use the present value of an annuity factor if cash flows are equal across years. Problem 24-2A: Project Y Evaluation 1. Compute Annual Net Cash Flows: o Annual net cash flow is calculated by adding non-cash expenses like depreciation to the annual income. 2. Determine Payback Period: o Use the payback period formula to determine how many years it will take to recover the initial investment of $350,000. 3. Compute ARR: o ARR Formula: ARR=Annual IncomeAverage Investment o Average investment for four years with no salvage is half of the initial investment. 4. Determine NPV: o Discount the cash flows using an 8% rate and compute the NPV by subtracting the initial investment. Problem 24-3A: Comparison of Projects Y and Z 1. Compute Annual Net Cash Flows for Each Project: o Use project details to add back any non-cash expenses for both projects. 2. Calculate Payback Periods: o Determine which project has a shorter payback period if based solely on payback time. 3. Compute ARR for Each Project: o Calculate ARR to see which project yields a higher return based on income and average investment. 4. Calculate NPV Using an 8% Discount Rate: o Discount net cash flows for each project and compare NPVs to select the preferred project. Problem 24-4A: NPV and Profitability Index for Projects A and B 1. Compute NPV: o Discount each project’s annual cash flows at the 8% required rate of return. 2. Calculate Profitability Index: o Profitability Index Formula: Profitability Index=Present Value of Cash FlowsInitial Investment o Choose the project with the higher profitability index if only one can be selected. Problem 24-5A: Payback Period, BET, and NPV for Salsa Company 1. Determine Payback Period: o Calculate how many years it takes for cumulative net cash flows to cover the initial $250,000 investment. 2. Calculate Break-Even Time (BET): o BET accounts for the time value of money, so calculate cumulative discounted cash flows until they equal the initial investment. 3. Compute NPV: o Discount future cash flows at 10% and subtract the initial investment for the NPV. 4. Decision Based on NPV: o Recommend investing if NPV > 0. Problem 24-6A: NPV Comparison for Interstate Manufacturing’s Alternatives 1. Compute NPV for Alternative 1: o Calculate NPV by discounting each of the $50,000 annual cash flows for five years, plus the discounted salvage value at the end of year 5. 2. Compute NPV for Alternative 2: o Calculate NPV of the $65,000 annual cash flows, considering the sale of the old machine as part of initial cash flows. 3. Decision Based on NPV: o Choose the alternative with the higher NPV, as it offers the greater financial return.