Answer:
Most Company
a. Annual expected net cash flows:
Project Y Project Z
Net cash flows before tax 139,500 122,200
Expected net cash flows:
Income taxes (38%) 31,160 20,216
Net cash flows after tax 108,340 101,984
b. Accounting rate of return:
= Annual Net Income/Average Investment
Project Y:
= $50,840/$278,000 * 100
= 18.29%
Project Z:
= $32,984/$234,800 * 100
= 14.05%
c. Net Present Value, using 6% discount rate:
Annuity PV Project Y Project Z
Annuity factor = 4.212
Annuity of operating outflows 929,746 698,350
Initial Investments 345,000 345,000
Total PV of investments $1,274,746 $1,043,350
Annuity of cash inflows $1,516,320 $1,213,056
Net present value $241,574 $169,706
Explanation:
a) Data and Calculations:
1. Investments in Projects:
Project Y Project Z
Investments $345,000 $345,000
Project's life 6 years 5 years
Salvage value 0 0
Depreciation method = straight-line method
Annual Depreciation expenses $57,500 $69,000
2. Cash Inflows:
Sales 360,000 288,000
3. Cash Outflows:
Direct materials 50,400 36,000
Direct labor 72,000 43,200
Overhead 72,100 60,600
Selling & Admin. expenses 26,000 26,000
Total Operating Outflows 220,500 165,800
Net cash flows before tax 139,500 122,200
Expected net cash flows:
Income taxes (38%) 31,160 20,216
Net cash flows after tax 108,340 101,984
4. Accounting rate of returns calculations:
Project Y Project Z
Annual Net income $50,840 $32,984
Project's life 6 years 5 years
Initial Investments 345,000 345,000
Annual Cash Outflows 220,500 165,800
Total Cash Outflows 1,323,000 829,000
Total Investments 1,668,000 1,174,000
Average Investments $278,000 $234,800
Average investments = total investments/number of project's years.
5. Most Company's accounting rate of return measures the average annual net income as a percentage of the average investments, without considering the time value of money.
6. Most Company's NPV or net present value of a project calculates the difference between the present values of the inflows and the outflows of a project over its life.
