Accounting Chapter 12 7 Compute the amount of annual before-tax savings that must be generated by the new tractor to have a payback period of 3 years.

149. The Zone Company is considering the purchase of a new machine at a cost of $1,040,000.

The machine is expected to improve productivity and thereby increase cash inflows by $250,000

per year for 7 years. It will have no salvage value. The company requires a minimum rate of return

of 12 percent on this type of capital investment. (Ignore income taxes for this problem.)

Required:

1. Determine the net present value (NPV) of the investment proposal. (The PV annuity factor for

12%, 7 years is 4.564.)

2. Determine the proposal’s internal rate of return (IRR), rounded to the nearest tenth of a

percent. (

Note

: PV annuity factors for 7 years: @ 10% = 4.868; @ 11% = 4.712; @ 12% = 4.564; @

13% = 4.423; @ 14% = 4.288; @ 15% = 4.160; and, @ 20% = 3.605.)

3. What is the estimated payback period for the proposed investment, under the assumption that

cash inflows occur evenly throughout the year? Round your answer to 2 decimal places.

4. What is the present value payback period for the proposed investment? Round your answer to

2 decimal places.

5. What is the estimated accounting rate of return (on initial investment) for the proposed

project? Round your answer to 1 decimal place, e.g., 0.1224 = 12.2%.

150. Said Company is considering the purchase of a new piece of equipment for $45,000. The

projected after-tax net income associated with this investment is $3,000 for each of the next

three years. The company uses straight-line depreciation. The machine has a useful life of 3

years and no salvage value. Management of the company considers a 12% return on investment

to be satisfactory.

Required:

1. What is the discounted payback period for this investment? (The appropriate discount factors

for 12% are as follows: Year 1 = 0.893; Year 2 = 0.797; and Year 3 = 0.712.)

2. What is the estimated net present value (NPV) of this proposed investment?

151. George’s Garage is considering purchasing a machine for $75,000. The machine is

expected to generate a net after-tax income of $11,250 per year. This machine is to be

depreciated over a 10-year period with no residual value.

Required:

What is the payback period, in years, for this machine? (Assume that the cash inflows from this

investment occur evenly throughout the year.)

152. National Rodeo Association, a not–for-profit organization, is considering purchasing a

new enterprise software system for $90,000. This investment is projected to have an eight-year

useful life, and a salvage value of $8,800. Its anticipated eight-year life is projected to save the

organization approximately $18,000 each year in operating costs. In addition, the association

needs an increase of $5,000 in net working capital (other than cash) in the first year, which will

not be released (that is, converted back to cash) until the end of eight years.

Required:

1. What is the payback period for this proposed investment? (Assume that the cash flows, other

than salvage value, occur evenly throughout the year. Also, round your answer to 2 decimal

places, e.g., 2.452 years = 2.45 years.)

2. If the Association has a required rate of return of 10 percent, what is the net present value

(NPV) of this investment? Round your calculation to whole dollars (i.e., zero decimal points). (The

PV annuity factor for 10%, 8 years is 5.335, while the PV $1 factor for 10%, 8 years is 0.467.)

3. What is the estimated internal rate of return (IRR) on this project (to the nearest whole

percent)? (Note: The following present value factors are taken from the present value tables in

Appendix C of Chapter 12, for an 8-year period. This information is needed to answer the

question.)

@ 10% @ 11% @12% @13%

PV $1 discount factor 0.467 0.434 0.404 0.376

PV annuity factor 5.335 5.146 4.968 4.799

153. Megan Inc. has a policy of not accepting any investment proposal that requires more than

three years to payback. The company is considering the purchase of new drafting equipment for

$630,000. The equipment has an estimated useful life of seven years. Megan will use straight-

line depreciation for this asset, with no salvage value. Megan’s income tax rate is approximately

25%.

Required:

Determine the required before-tax savings for the drafting equipment to meet the company’s

payback requirement.

154. Durable Inc. is considering replacing an old drilling machine that cost $200,000 six years

ago with a new one that costs $450,000. Shipping and installation cost an additional $60,000. The

old machine has been depreciated using the straight-line (SL) method with no salvage value over

an estimated 8-year useful life. The old machine can be sold for $40,000 now or $10,000 in two

years. Management expects increases in inventories of $10,000, accounts receivable of $32,000,

and accounts payable of $12,000 if the new machine is acquired. Durable’s income tax rate is

expected to be 30 percent over the years affected by the investment.

Required:

What is Durable’s net initial investment (i.e., its after-tax initial cash outlay for the machine)?

155. Fieldgard Inc. invested $800,000 in a project nine years ago. This project has generated

$320,000 cash revenues per year and incurred $250,000 cash operating costs each year. The

project qualified as 7-year property under MACRS (modified accelerated cost recovery system).

Salvage value of this project (at the end of the tenth, and final, year of the project’s life) is

expected to be $200,000. The project required $80,000 net additional working capital at its

inception and another $60,000 at the end of year 5. The combined increased working capital

commitment is expected to be fully recoverable when the project terminates. The company is

subject to a combined 40% income tax rate.

Required:

What is the expected total after-tax cash flow expected from this project next year (i.e., during

the 10th and final year of the project’s life)?

156. Six years ago, Nebrow Inc. purchased a polishing machine for $600,000. The company

expected to use the machine for 10 years with no residual value at the end of the tenth year. The

machine has been generating annual cash revenue of $460,000 and incurring annual cash

operating costs of $210,000. Nebrow is considering the purchase of a new digital polishing

machine for $800,000, which will have annual cash revenues of $690,000 and annual cash

operating costs of $180,000. The new machine is expected to have a useful life of four years. The

company uses the straight-line depreciation method with no salvage value to depreciate all of its

assets. Assume, for purposes of analysis, that Nemrow is subject to a combined 40% tax rate.

Required:

What is the annual incremental after-tax cash flow from the new polishing machine?

157. Solich Company is evaluating a new tractor that costs $1,350,000 to replace the tractor

purchased years earlier, which currently has no salvage value; the new tractor has an estimated

useful life of five years with no disposal value or anticipated cost of disposal. The company uses

straight-line depreciation with no residual value on all equipment. Solich is subject to a 40%

income tax rate. The company uses a 12% hurdle rate for evaluating capital investment projects.

The PV of an annuity of $1 at 12% for 5 years is 3.605, and the PV of $1 at 12% in 5 years is

0.567.

Required:

1. Compute the amount of annual before-tax savings that must be generated by the new tractor

to have a payback period of 3 years.

2. Compute the amount of before-tax savings that must be generated by the new tractor to have

an NPV of $500,000 at a discount rate of 12%. (Round your answer to the nearest whole dollar

amount.)

3. Compute the amount of before-tax savings that must be generated by the new tractor to have

an IRR of 12%.

158. Grey Inc. is considering purchasing a machine for $50,000, which is expected to generate

an annual after-tax income of $10,000 and is to be depreciated over 5 years with no residual

value.

Required:

1. Under the assumption that cash inflows occur evenly throughout the year, what is the payback

period for this machine? (Round answer to one decimal point.)

2. Based on the initial investment outlay, what is the anticipated accounting rate of return (ARR)

on this investment?

3. What is the anticipated internal rate of return (IRR) on this investment? (Note: To answer this

question, you will need to have access to Excel or the present value tables presented as

Appendix C to Chapter 12.)

4. Assume a discount rate (i.e., cost of capital) of 15%:

159. Green Leaf Inc. is considering the purchase of a new piece of equipment for $30,000. The

projected after-tax net income per year on this investment is estimated to be $5,000. The firm

uses straight-line depreciation. This asset is expected to have a useful life of 5 years and no

salvage value at the end of its useful life. Management of the company estimates that its

weighted-average cost of capital (WACC) is 10%. The present value factor for 10%, 5 years =

0.621, while the present value annuity factor for 5 years at 10% is 3.791.

Required:

1. What is the estimated net present value (NPV) of the machine?

2. What is the profitability index (PI) for this proposed investment? (Round your answer to two

decimal places.)

3. For what purpose is the profitability index (PI) useful, in a capital budgeting context?

4. Use the built-in function in Excel to estimate this project’s internal rate of return (IRR).

5. Use the built-in function in Excel to estimate the project’s modified internal rate of return

(MIRR) under the assumption that the interim cash flows from the investment generate a rate of

return of: (a) 10%, and (b) 20%.

6. How does the MIRR measure differ from the conventional IRR calculation?