chapter 12 part #2

Question 1

York Company needs a new milling machine. The company is considering two machines: machine A and machine B. Machine A costs $15,000, has a useful life of ten years, and will reduce operating costs by $5,000 per year. Machine B costs only $12,000, will also reduce operating costs by $5,000 per year, but has a useful life of only five years. Which machine should be purchased according to the payback method? Why?

Answer 1

Machine A Payback Period = $15,000 / $5,000 = 3.0 years
Machine B Payback Period = $12,000 / $5,000 = 2.4 years

Question 2

method compares the present value of a project’s cash inflows to the present value of its cash outflows.

Answer 2

net present value

Question 3

the average rate of return that the company must pay to its long-term creditors and its shareholders for the use of their funds. (screening device)

Answer 3

cost of capital

Question 4

the value of a project after depreciation

Answer 4

salvage value

Question 5

actual cash outlays for salaries, advertising, and other operating expenses

Answer 5

Out-of-pocket costs

Question 6

Sales
$150,000
VE
$90,000
CM
$60,000
FE:

Salaries
$27,000
Maintenance
$3,000
Depreciation
$10,000
Total FE
$40,000
NOI
$20,000

Example: Goodtime Fun Centers, Inc., operates amusement parks. Some of the vending machines in one of its parks provide very little revenue, so the company is considering removing the machines and installing equipment to dispense soft ice cream. The equipment would cost $80,000 and have an eight-year useful life with no salvage value. Incremental annual revenues and costs associated with the sale of ice cream would be as follows:
The vending machine can be sold for a $5,000 scrap value. The company will not purchase the equipment unless it has a payback period of three years or less. Does the ice cream dispenser pass this hurdle?

Answer 6

Step 1: Compute the annual net cash inflow
NOI
$20,000
Add: Depreciation (Noncash)
$10,000
Annual Net Cash Inflow
$30,000

Step 2: Compute the payback period
Cost of the new equipment
$80,000
Less: Salvage Value of Old Equipment
$5,000
Investment Required
$75,000

Payback Period = $75,000 / $30,000 = 2.5 years 🡪 Yes