60 Managerial Accounting for Managers, 4th Edition
Exercise 8A-5 (10 minutes)
1. From Exhibit 8B-2, the factor for 16% for 8 periods is 4.344. The
computer system should be purchased only if its net present value is
positive. This will occur only if the purchase price is less:
2. From Exhibit 8B-2, the factor for 20% for 8 periods is 3.837. Therefore,
the maximum purchase price would be:
Solutions Manual, Appendix 8A 61
Exercise 8A-6 (10 minutes)
1. From Exhibit 8B-2, the factor for 12% for 20 periods is 7.469. Thus, the
present value of Mr. Ormsby’s winnings is:
2. Whether or not it is correct to say that Mr. Ormsby is the state’s newest
millionaire depends on your point of view. He will receive more than a
62 Managerial Accounting for Managers, 4th Edition
Appendix 8C
Income Taxes and Net Present Value Analysis
Exercise 8C-1 (10 minutes)
The project’s net present value is computed as follows:
Now
1
2
3
4
Purchase of
equipment …………….
$(2,000,000)
Sales ……………………
$2,800,000
$2,800,000
$2,800,000
$2,800,000
Variable expenses …..
(1,600,000)
(1,600,000)
(1,600,000)
(1,600,000)
Out-of-pocket costs …
(500,000)
(500,000)
(500,000)
(500,000)
Income tax expense
($300,000 × 30%) ….
__________
(90,000)
(90,000)
(90,000)
(90,000)
Total cash flows (a) ..
$(2,000,000)
$610,000
$610,000
$610,000
$610,000
Discount factor (b) ….
1.000
0.885
0.783
0.693
0.613
Present value
(a)×(b) ………………..
$(2,000,000)
$539,850
$477,630
$422,730
$373,930
$331,230
Net present value …..
$145,370
Note: The present value of the net cash inflows from years 1 through 5 can also be computed using the
Solutions Manual, Appendix 8C 63
Exercise 8C-2 (20 minutes)
The net present value of the new product is computed as follows:
Now
1
2
3
4
5
Annual tax expense
:
Sales ………………………….
$250,000
$250,000
$250,000
$250,000
$250,000
Variable expenses ………...
(120,000)
(120,000)
(120,000)
(120,000)
(120,000)
Out-of-pocket costs ……….
(70,000)
(70,000)
(70,000)
(70,000)
(70,000)
Depreciation expense …….
(26,000)
(26,000)
(26,000)
(26,000)
(26,000)
Incremental net income ...
$ 34,000
$ 34,000
$ 34,000
$ 34,000
$ 34,000
Tax rate ……………………..
30%
30%
30%
30%
30%
Income tax expense ……...
$(10,200)
$(10,200)
$(10,200)
$(10,200)
$(10,200)
Net present value
:
Purchase equipment ……..
$(130,000)
Sales ………………………….
$250,000
$250,000
$250,000
$250,000
$250,000
Variable expenses ………...
(120,000)
(120,000)
(120,000)
(120,000)
(120,000)
Out-of-pocket costs ……….
(70,000)
(70,000)
(70,000)
(70,000)
(70,000)
Income tax expense ……...
________
(10,200)
(10,200)
(10,200)
(10,200)
(10,200)
Total cash flows (a) ……...
$(130,000)
$ 49,800
$ 49,800
$ 49,800
$ 49,800
$ 49,800
Discount factor (b) ………..
1.000
0.870
0.756
0.658
0.572
0.497
Present value (a) × (b) ….
$(130,000)
$43,326
$37,649
$32,768
$28,486
$24,751
Net present value ………...
$36,980
64 Managerial Accounting for Managers, 4th Edition
Problem 8C-3 (30 minutes)
The net present value of the project is computed as follows:
Now
1
2
3
4
5
Annual tax expense
:
Sales ……………………….…
$350,000
$350,000
$350,000
$350,000
$350,000
Variable expenses …………
(180,000)
(180,000)
(180,000)
(180,000)
(180,000)
Out-of-pocket costs …….…
(80,000)
(80,000)
(80,000)
(80,000)
(80,000)
Overhaul of equipment ..…
(18,000)
Depreciation expense ….…
(50,000)
(50,000)
(50,000)
(50,000)
(50,000)
Incremental net income
$ 40,000
$ 22,000
$ 40,000
$ 40,000
$ 40,000
Tax rate …………………..…
30%
30%
30%
30%
30%
Income tax expense ………
$(12,000)
$(6,600)
$(12,000)
$(12,000)
$(12,000)
Net present value
:
Purchase equipment …..…
$(250,000)
Working capital ………….…
(60,000)
Sales ……………………….…
$350,000
$350,000
$350,000
$350,000
$350,000
Variable expenses …………
(180,000)
(180,000)
(180,000)
(180,000)
(180,000)
Out-of-pocket costs …….…
(80,000)
(80,000)
(80,000)
(80,000)
(80,000)
Overhaul of equipment ..…
(18,000)
Release working capital .…
60,000
Income tax expense ………
________
(12,000)
(6,600)
(12,000)
(12,000)
(12,000)
Total cash flows (a) ………
$(310,000)
$ 78,000
$ 65,400
$ 78,000
$ 78,000
$ 138,000
Discount factor (b) ……..…
1.000
0.893
0.797
0.712
0.636
0.567
Present value (a) × (b) .…
$(310,000)
$69,654
$52,124
$55,536
$49,608
$78,246
Net present value …………
$(4,832)
Solutions Manual, Appendix 8C 65
Problem 8C-4 (30 minutes)
The net present value of the project is computed as follows:
Now
1
2
3
4
5
Annual tax expense
:
Sales ………………………….
$410,000
$410,000
$410,000
$410,000
$410,000
Variable expenses ………...
(175,000)
(175,000)
(175,000)
(175,000)
(175,000)
Out-of-pocket costs ……….
(100,000)
(100,000)
(100,000)
(100,000)
(100,000)
Equipment maintenance ...
(20,000)
(20,000)
Depreciation expense …….
(84,000)
(84,000)
(84,000)
(84,000)
(84,000)
Incremental net income ...
$ 51,000
$ 51,000
$ 31,000
$ 31,000
$ 51,000
Tax rate ……………………..
30%
30%
30%
30%
30%
Income tax expense ……...
$(15,300)
$(15,300)
$(9,300)
$(9,300)
$(15,300)
Net present value
:
Purchase equipment ……..
$(420,000)
Working capital …………….
(65,000)
Sale of old equipment …...
$80,000
Sales ………………………….
$410,000
$410,000
$410,000
$410,000
$410,000
Variable expenses ………...
(175,000)
(175,000)
(175,000)
(175,000)
(175,000)
Out-of-pocket costs ……….
(100,000)
(100,000)
(100,000)
(100,000)
(100,000)
Equipment maintenance ...
(20,000)
(20,000)
Release working capital ….
65,000
Income tax expense ……...
________
(15,300)
(15,300)
(9,300)
(9,300)
(15,300)
Total cash flows (a) ……...
$(405,000)
$119,700
$119,700
$105,700
$105,700
$184,700
Discount factor (b) ………..
1.000
0.893
0.797
0.712
0.636
0.567
Present value (a) × (b) ….
$(405,000)
$106,892
$95,401
$75,258
$67,225
$104,725
Net present value ………...
$44,501
66 Managerial Accounting for Managers, 4th Edition
Problem 8C-5 (45 minutes)
Now
1
2
3
4
5
Annual tax expense
:
Sales ……………………….…
$370,000
$370,000
$370,000
$370,000
$370,000
Operating expenses ………
(200,000)
(200,000)
(200,000)
(200,000)
(200,000)
Repairs…………………….…
(45,000)
Depreciation expense ….…
(80,000)
(80,000)
(80,000)
(80,000)
(80,000)
Incremental net income
$90,000
$90,000
$ 45,000
$90,000
$90,000
Tax rate …………………..…
30%
30%
30%
30%
30%
Income tax expense ………
$(27,000)
$(27,000)
$(13,500)
$(27,000)
$(27,000)
Net present value
:
Purchase equipment …..…
$(400,000)
Working capital ………….…
(85,000)
Sales ……………………….…
$370,000
$370,000
$370,000
$370,000
$370,000
Operating expenses ………
(200,000)
(200,000)
(200,000)
(200,000)
(200,000)
Repairs…………………….…
(45,000)
Release working capital .…
85,000
Income tax expense ………
________
(27,000)
(27,000)
(13,500)
(27,000)
(27,000)
Total cash flows (a) ………
$(485,000)
$143,000
$143,000
$111,500
$143,000
$228,000
Discount factor (b) ……..…
1.000
0.877
0.769
0.675
0.592
0.519
Present value (a) × (b) .…
$(485,000)
$125,411
$109,967
$75,263
$84,656
$118,332
Net present value …………
$28,629
Solutions Manual, Appendix 8C 67
Problem 8C-5 (continued)
Now
1
2
3
4
5
Annual tax expense
:
Sales ……………………….…
$390,000
$390,000
$390,000
$390,000
$390,000
Operating expenses ………
(170,000)
(170,000)
(170,000)
(170,000)
(170,000)
Repairs…………………….…
(70,000)
Depreciation expense ….…
(110,000)
(110,000)
(110,000)
(110,000)
(110,000)
Incremental net income
$110,000
$110,000
$ 40,000
$110,000
$110,000
Tax rate …………………..…
30%
30%
30%
30%
30%
Income tax expense ………
$(33,000)
$(33,000)
$(12,000)
$(33,000)
$(33,000)
Net present value
:
Purchase equipment …..…
$(550,000)
Working capital ………….…
(60,000)
Sales ……………………….…
$390,000
$390,000
$390,000
$390,000
$390,000
Operating expenses ………
(170,000)
(170,000)
(170,000)
(170,000)
(170,000)
Repairs…………………….…
(70,000)
Release working capital .…
60,000
Income tax expense ………
________
(33,000)
(33,000)
(12,000)
(33,000)
(33,000)
Total cash flows (a) ………
$(610,000)
$187,000
$187,000
$138,000
$187,000
$247,000
Discount factor (b) ……..…
1.000
0.877
0.769
0.675
0.592
0.519
Present value (a) × (b) .…
$(610,000)
$163,999
$143,803
$93,150
$110,704
$128,193
Net present value …………
$29,849
68 Managerial Accounting for Managers, 4th Edition
Problem 8C-5 (continued)
2. Students should use the project profitability index to answer this
question as follows:
Product A
Product B
Net present value (a) ………………………………
$28,629
$29,849
Investment required (b) …………………………..
$485,000
$610,000
Project profitability index (a) ÷ (b) ……………..
0.059
0.049
Although Product A has the lower net present value, it has the higher