Solutions Manual, Chapter 8 31
Problem 8-19 (continued)
3. The formula for the payback period is:
Investment required
Payback period = Annual net cash inflow
$270,000
= = 4.5 years
$60,000*
*Net operating income + Depreciation = Annual net cash inflow
$43,200 + $16,800 = $60,000
According to the payback computation, the franchise would not be
32 Managerial Accounting for Managers, 4th Edition
Problem 8-20 (30 minutes)
1. The annual net cost savings would be:
Reduction in labor costs …………………………………..
$108,000
Reduction in material waste ……………………………..
6,500
Total ……………………………………………………………
114,500
Less increased maintenance costs ($3,000 × 12) ….
36,000
Annual net cost savings …………………………………..
$ 78,500
2. Using this cost savings figure, and other data from the text, the net present value analysis would be:
Now
1
2
3
4
5
6
Cost of machine …………….
$(250,000)
Software and installation …
(80,000)
Salvage value of old
equipment ……………………
12,000
Annual net cost savings …..
$78,500
$78,500
$78,500
$78,500
$78,500
$78,500
Replacement of parts ……..
(45,000)
Salvage value of new
machine ………………………
_______
______
______
______
______
______
20,000
Total cash flows (a) ……….
$(318,000)
$78,500
$78,500
$33,500
$78,500
$78,500
$98,500
Discount factor (16%) (b) .
1.000
0.862
0.743
0.641
0.552
0.476
0.410
Present value (a)×(b) …….
$(318,000)
$67,667
$58,326
$21,474
$43,332
$37,366
$40,385
Net present value ………….
$(49,450)
Problem 8-20 (continued)
34 Managerial Accounting for Managers, 4th Edition
Problem 8-21 (30 minutes)
1. The formula for the project profitability index is:
Net present value of the project
Project profitability index = Investment required by the project
The indexes for the projects under consideration would be:
Project 1:
$66,140 ÷ $270,000 = 0.24
Project 2:
$72,970 ÷ $450,000 = 0.16
Project 3:
$73,400 ÷ $360,000 = 0.20
Project 4:
$87,270 ÷ $480,000 = 0.18
2. a., b., and c.
Net Present
Value
Project
Profitability
Index
Internal Rate
of Return
First preference ……..
4
1
2
Second preference ….
3
3
1
Third preference …….
2
4
4
Fourth preference …..
1
2
3
Solutions Manual, Chapter 8 35
Problem 8-21 (continued)
3. Which ranking is best will depend on Revco Products’ opportunities for
reinvesting funds as they are released from the project. The internal
The project profitability index approach assumes that funds released
from a project are reinvested in other projects at a rate of return equal
The net present value is inferior to the project profitability index as a
ranking device because it looks only at the total amount of net present
36 Managerial Accounting for Managers, 4th Edition
Problem 8-22 (20 minutes)
1. The annual net cash inflows would be:
Reduction in annual operating costs:
Operating costs, present hand method …..
$30,000
Operating costs, new machine ……………..
7,000
Annual savings in operating costs …………
23,000
Increased annual contribution margin:
6,000 boxes × $1.50 per box ……………….
9,000
Total annual net cash inflows …………………
$32,000
2. The net present value is computed as follows:
Now
1
2
3
4
5
Purchase of machine ……..
$(120,000)
Annual net cash inflows ….
$32,000
$32,000
$32,000
$32,000
$32,000
Replacement parts ………..
(9,000)
Salvage value of machine .
________
______
______
_______
______
7,500
Total cash flows (a) ………
$(120,000)
$32,000
$32,000
$23,000
$32,000
$39,500
Discount factor (20%) (b)
1.000
0.833
0.694
0.579
0.482
0.402
Present value (a)×(b) ……
$(120,000)
$26,656
$22,208
$13,317
$15,424
$15,879
Net present value …………
(26,516)
Solutions Manual, Chapter 8 37
Problem 8-23 (45 minutes)
follows:
Product A
Product B
Sales revenues ……………………………….
$250,000
$350,000
Variable expenses …………………………..
(120,000)
(170,000)
Fixed out-of-pocket operating costs ……
(70,000)
(50,000)
Annual net cash inflows ……………………
$ 60,000
$130,000
follows:
Product A
Product B
Investment required (a) ……………………
$170,000
$380,000
Annual net cash inflow (b) ………………..
$60,000
$130,000
Payback period (a) ÷ (b) ………………….
2.83 years
2.92 years
38 Managerial Accounting for Managers, 4th Edition
Problem 8-23 (continued)
Product A:
Now
1
2
3
4
5
Purchase of equipment ..….
$(170,000)
Sales ……………………….….
$250,000
$250,000
$250,000
$250,000
$250,000
Variable expenses ………….
(120,000)
(120,000)
(120,000)
(120,000)
(120,000)
Fixed out-of-pocket
costs ……………………….….
(70,000)
(70,000)
(70,000)
(70,000)
(70,000)
Total cash flows (a) ……….
$(170,000)
$60,000
$60,000
$60,000
$60,000
$60,000
Discount factor (b) ……..….
1.000
0.862
0.743
0.641
0.552
0.476
Present value (a)×(b) …….
$(170,000)
$51,720
$44,580
$38,460
$33,120
$28,560
Net present value ………….
$26,440
Product B:
Now
1
2
3
4
5
Purchase of equipment ..….
$(380,000)
Sales ……………………….….
$350,000
$350,000
$350,000
$350,000
$350,000
Variable expenses ………….
(170,000)
(170,000)
(170,000)
(170,000)
(170,000)
Fixed out-of-pocket
costs ……………………….….
(50,000)
(50,000)
(50,000)
(50,000)
(50,000)
Total cash flows (a) ……….
$(380,000)
$130,000
$130,000
$130,000
$130,000
$130,000
Discount factor (b) ……..….
1.000
0.862
0.743
0.641
0.552
0.476
Present value (a)×(b) …….
$(380,000)
$112,060
$96,590
$83,330
$71,760
$61,880
Net present value ………….
$45,620
Solutions Manual, Chapter 8 39
Problem 8-23 (continued)
3. The internal rate of return for each product is calculated as follows:
Product A
Product B
Investment required (a) …………………………..
$170,000
$380,000
Annual net cash inflow (b) ………………………..
$60,000
$130,000
Factor of the internal rate of return (a) ÷ (b) ..
2.833
2.923
Looking in Exhibit 8B-2 and scanning along the 5-period line, a factor of
4. The project profitability index for each product is computed as follows:
Product A
Product B
Net present value (a) ………………………………
$26,440
$45,620
Investment required (b) …………………………..
$170,000
$380,000
Project profitability index (a) ÷ (b) ……………..
0.16
0.12
5. The simple rate of return for each product is computed as follows:
Product A
Product B
Annual net cash inflow …………………………….
$60,000
$130,000
Depreciation expense ………………………………
34,000
76,000
Annual incremental net operating income …….
$26,000
$54,000
Product A
Product B
Annual incremental net operating income (a)..
$26,000
$54,000
Initial investment (b) ……………………………….
$170,000
$380,000
Simple rate of return (a) ÷ (b) …………………..
15.3%
14.2%
6. The net present value calculations suggest that Product B is preferable
to Product A. However, the project profitability index reveals that
Problem 8-24 (45 minutes)
1.
Present cost of transient workers ……………………..
$40,000
Less out–of-pocket costs to operate the cherry picker:
Cost of an operator and assistant …………………..
$14,000
Insurance ………………………………………………….
200
Fuel …………………………………………………………
1,800
Maintenance contract …………………………………..
3,000
19,000
Annual savings in cash operating costs ………………
$21,000
2. The first step is to determine the annual incremental net operating
income:
Annual savings in cash operating costs ………….
$21,000
Less annual depreciation ($90,000 ÷ 12 years) .
7,500
Annual incremental net operating income ………
$13,500
Annual incremental net operating income
Simple rate of return = Initial investment
$13,500
= = 14.3% (rounded)
$94,500
3. The formula for the payback period is:
Investment required
Payback period = Annual net cash inflow
$94,500
= = 4.5 years
$21,000*
*
In this case, the cash inflow is measured by the annual savings
in cash operating costs.