Accounting Chapter 24 Homework This is because although both projects have a positive net present value

Problem 24-2B (Continued)

Part 4

PROJECT A

Present Value of Net Cash Flows

Present

Value of

Net Cash

Flows

1 at 8%

Annuity

Net Cash

Flows

Years 1-4 ……………………………………………….

3.3121

$330,879

Net present value …………………………………..

$ 90,879

PROJECT B

Present Value of Net Cash Flows

Present

Value of

Net Cash

Flows

1 at 8%

Annuity

Net Cash

Flows

Years 1-3 ……………………………………………….

$105,900

2.5771

$272,915

Amount invested ……………………………………

(240,000)

Net present value …………………………………..

$ 32,915

Problem 24-3B (60 minutes)

Part 1

RESULTS USING STRAIGHT-LINE DEPRECIATION

(a)

Income

Before

Deprec.

(b)

Straight–

Line

Deprec.

(c)

Taxable

Income

(a) – (b)

(d)

40%

Income

Taxes

(e)

Net Cash

Flows

(a) – (d)

Year 1 ……………………….

$3,000

$3,600

$8,400

Year 3 ……………………….

12,000

6,000

2,400

9,600

Year 4 ……………………….

12,000

6,000

2,400

9,600

Year 5 ……………………….

12,000

6,000

2,400

9,600

Year 6 ……………………….

12,000

3,000

9,000

3,600

8,400

Part 2

RESULTS USING MACRS DEPRECIATION

(a)

Income

Before

Deprec.

(b)

MACRS

Deprec.

(c)

Taxable

Income

(a) – (b)

(d)

40%

Income

Taxes

(e)

Net Cash

Flows

(a) – (d)

Year 1 ……………………….

$12,000

$6,000

$ 6,000

$2,400

$ 9,600

Year 2 ……………………….

12,000

9,600

2,400

960

11,040

Year 3 ……………………….

12,000

5,760

6,240

2,496

9,504

Year 4 ……………………….

12,000

3,456

8,544

3,418

8,582

Year 5 ……………………….

12,000

3,456

8,544

3,418

8,582

Year 6 ……………………….

12,000

1,728

10,272

4,109

7,891

Problem 24-3B (Continued)

Part 3

NET PRESENT VALUE OF ASSET USING STRAIGHT-LINE DEPRECIATION

Present

Net Cash

Value of

Value of Net

Flows

1 at 10%

Cash Flows

Year 1 …………………………………………………..

$ 8,400

0.9091

$ 7,636

Year 2 …………………………………………………..

9,600

0.8264

7,933

Year 3 …………………………………………………..

9,600

0.7513

7,212

Year 4 …………………………………………………..

9,600

0.6830

6,557

Year 5 …………………………………………………..

9,600

0.6209

5,961

Totals …………………………………………………..

$55,200

$40,041

Part 4

NET PRESENT VALUE OF ASSET USING MACRS DEPRECIATION

Present

Net Cash

Value of

Value of Net

Flows

1 at 10%

Cash Flows

Year 1 …………………………………………………..

$ 9,600

0.9091

$ 8,727

Year 2 …………………………………………………..

11,040

0.8264

9,123

Year 3 …………………………………………………..

9,504

0.7513

7,140

Year 4 …………………………………………………..

8,582

0.6830

5,862

Year 5 …………………………………………………..

8,582

0.6209

5,329

Year 6 …………………………………………………..

7,891

0.5645

4,454

Totals …………………………………………………..

$55,199

$40,635

Amount invested …………………………………..

(30,000)

Net present value ………………………………….

$10,635

Part 5

Analysis: The net present value using MACRS depreciation is greater than the

net present value using straight-line depreciation because the cash flows are

larger in the earlier years of the asset’s life under MACRS depreciation. They

are larger because the depreciation deductions are larger, resulting in less

income taxes paid in the earlier years.

Problem 24-4B (45 minutes)

Part 1

Alternative 1: Keep the old freezer and have it repaired

Item

Period

Cash Flow

Present

Value Factor

at 10%

Present

Value of

Cash Flows

Revenues …………………………..

1 – 8

$63,000

5.3349

$ 336,099

Operating costs………………….

1 – 8

(55,000)

5.3349

(293,420)

Salvage value …………………….

8

3,000

0.4665

1,400

Total ………………………………….

44,079

Cost of repair ……………………..

(50,000)

Net present value ……………….

$ (5,921)

*Note that the cost of the old freezer is irrelevant because it is a sunk cost.

Part 2

Alternative 2: Sell the old freezer and buy a new one

Item

Period

Cash Flow

Present

Value Factor

at 10%

Present

Value of

Cash Flows

Part 3

Archer should sell the old freezer and buy a new one. The operating costs

of the old freezer are so much higher than that of the new freezer, even

after the old freezer has been repaired. Keeping the old freezer has a

negative net present value, and although the initial cash outlay is more to

buy the new freezer, it is the better investment.

Problem 24-5B (40 minutes)

Part 1: Payback period

Period

Cash flow

Cumulative cash flow

0 …………………………………………………………………..

1 …………………………………………………………………..

2 …………………………………………………………………..

3 …………………………………………………………………..

4 …………………………………………………………………..

The payback period is about 2.4 years.

Part 2: Break-even time

Period

Cash Flow

Present Value

of 1 at 10%

Present Value

of Cash Flows

Cumulative

Present Value

of Cash Flows

0 ……………….

$(800,000)

1.0000

$(800,000)

1 ……………….

300,000

0.9091

272,730

(527,270)

2 ……………….

350,000

0.8264

289,240

(238,030)

3 ……………….

400,000

0.7513

300,520

62,490

4 ……………….

450,000

0.6830

307,350

369,840

$238,030 / $300,520 = 0.8

The break-even time is about 2.8 years.

Part 3: Net present value

From the chart in part 2, we can see that the net present value of the

investment is $369,840.

Part 4

Problem 24-6B (40 minutes)

Part 1: Payback period

Period

Cash flow

Cumulative cash flow

0 …………………………………………………………………..

1 …………………………………………………………………..

2 …………………………………………………………………..

3 …………………………………………………………………..

4 …………………………………………………………………..

Part 2: Break-even time

Period

Cash Flow

Present Value

of 1 at 10%

Present Value

of Cash Flows

Cumulative

Present Value

of Cash Flows

0 ……………….

$(800,000)

1.0000

$(800,000)

1 ……………….

450,000

0.9091

409,095

(390,905)

2 ……………….

400,000

0.8264

330,560

(60,345)

3 ……………….

350,000

0.7513

262,955

202,610

4 ……………….

300,000

0.6830

204,900

407,510

$60,345 / $262,955 = 0.2 (rounded)

The break-even time is about 2.2 years.

SERIAL PROBLEM — SP 24

Serial Problem, Business Solutions (50 minutes)

COMPUTING NET CASH FLOWS FROM NET INCOME

Net income

Cash flows

Sales ……………………………………………………………………..

$375,000

Materials, labor & overhead ……………………………………

(200,000)

Depreciation* ……………………………………………………….

(50,000)

Selling and administrative ……………………………………..

(37,500)

Pretax income ……………………………………………………….

87,500

Income taxes (30%) ……………………………………………….

(26,250)

Net income ……………………………………………………….

$ 61,250

Net cash flows ……………………………………………………….

$111,250**

* Depreciation expense = $300,000 / 6 years = $50,000

** This equals the net income plus the depreciation expense ($61,250 + $50,000 = $111,250).

Company Analysis — AA 24-1

1. The internal rate of return (given here as 10%) is the rate which yields a

net present value of zero for an investment. The annuity factor for 10

periods and a discount rate of 10% is 6.1446. This means we can solve

for the amount of annual cash flows as follows:

$2.12 billion = Annual cash flows x 6.1446

Annual cash flows = $2.12 billion / 6.1446

Annual cash flows = $345,018,390 per year

For Apple’s initial investment of $2.12 billion to provide an internal rate

of return of 10% over 10 years, the investment must generate cash flows

of $345,018,390 per year for 10 years.

Comparative Analysis — AA 24-2

1. We know that the present value equals the annual cash flows times the

present value of an annuity factor for 7 periods, 15%. This means:

2. From its statement of cash flows (investing section), Google invested

$13,184 (millions) in capital assets in 2017.

3. Google invested more in capital assets in 2017 than Apple.

Global Analysis — AA 24-3

1. From its statement of cash flows for the year ended December 31, 2017,

Samsung invested 42,792,234 (in millions of Korean won) in acquisitions

of property, plant, and equipment in 2017.

Ethics Challenge — BTN 24-1

1. Present value of $100 to be received in 10 years assuming a 12%

discount rate is approximately $32. This is computed as $100 x 0.322.

2. We need to be concerned about any project with expected long-term

cash inflows. This is especially the case if the larger cash inflows are

expected later rather than sooner in the asset’s life. This concern is tied

to the riskiness of long-term predictions and the likely biases of

Communicating in Practice — BTN 24-2

Instructor note: Answers will vary, but responses should address the questions

asked and include some discussion of the following points for each method.

Payback Period

Accounting Rate

of Return

Net Present

Value

Internal Rate

of Return

Measurement

basis

• Cash flows

• Accrual income

• Cash flows

• Profitability

• Cash flows

• Profitability

Measurement

unit

• Periods

• Percent

• Dollars

• Percent

of project

Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 24

Taking It to the Net — BTN 24-3

Period

Cash flow

Cumulative cash flow

0 …………………………………………………………………..

$(15,000)

1 …………………………………………………………………..

1,000

(14,000)

2 …………………………………………………………………..

2,000

(12,000)

3 …………………………………………………………………..

3,000

(9,000)

4 …………………………………………………………………..

6,000

(3,000)

5 …………………………………………………………………..

7,000

4,000

$3,000/$7,000 = 0.43

The project has a payback period of 4.43 years, about 1.77 years more

than payback period for the original cash flows provided on the website.

Present

Value of

Net Cash

1 at 10%

1,653

2,254

4,098

Value of

Net Cash

The investment with the revised cash flows now has a negative net present

value of $(1,740), as opposed to the positive net present value of $563

using the original cash flows provided on the website.

This analysis shows that receiving cash flows from an investment sooner

is more desirable rather than receiving them later.

Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 24

Teamwork in Action — BTN 24-4

Instructor note: Answers will vary across students. Yet the examples, while

different, should capture similar qualitative factors.

SAMPLE SOLUTION

Project: Investment in an improved baggage handling system.

The new, improved baggage handling system is expected to increase both

customer satisfaction and likelihood of repeat business.

Qualitative Factors

• Competition has a new, more efficient and effective system.

• Need to replace old system.

Entrepreneurial Decision — BTN 24-5

1. Marco could use payback period, accounting rate of return, net present

value, and internal rate of return to evaluate whether this new

manufacturing facility and warehouse would be a good investment.

3.

Payback Period

Accounting Rate

of Return

Net Present

Value

Internal Rate

of Return

Advantages

• Easy to

understand

• Allows

comparison of

projects

• Easy to

understand

• Allows

comparison of

projects

• Reflects

time value

of money

• Reflects

different

risk levels

over

project’s life

• Reflects

time value

of money

• Allows

compari-

sons of

dissimilar

projects

Hitting the Road — BTN 24-6

1. Answers will vary among students.

Sample Example

For illustrative purposes, one sample solution would appear as follows:

Lease terms—$400 per month for 35 months; plus $10,000 final

payment at the end of 35 months; 12% annual interest rate.

To compute the present value of the lease payments

PV of 35 payments of $400 per month discounted

at 1% (12%/12 months) ……………………………………………………….

$11,763*

PV of $10,000 final payment at end of 35 months

discounted at 1% ………………………………………………………………….

7,059**

Total PV of lease ……………………………………………………………………..

$18,822

* $400 x 29.4086 (from Table B.3)

** $10,000 x 0.7059 (from Table B.1)

Purchase terms—$16,500