CPT Company wants to by a new product machine. The machine will provide the comp
ID: 2458832 • Letter: C
Question
CPT Company wants to by a new product machine. The machine will provide the company with a new product line: pressed food trays for kitchens. Two machines are being considered; the data for each machine follows: The company's minimum rate of return is 16 percent, and the maximum allowable payback period is 5 years. Compute the net present value for each machine. (Round to the nearest dollar.) Compute the profitability index for each machine. (Round to 2 decimal points.) Compute the accounting rate of return for each machine. (Round percentages to one decimal point, i.e. 13.1%.) Compute the payback for each machine. (Round to one decimal point.) From the Information generated in requirements 1, 2, 3, and 4, prepare a memo recommending which machine should be purchased.Explanation / Answer
Solution 1: Net present value:
ETZ: NPV = ( Annual Cash Flow * PVIFA(16%,10) ) + (salvage value * PVIF(16%,10)) - Initial investment
NPV =( $64404 * 4.883 + $25000 * 0.227) - $350,000
= - $29840.26
LKR: NPV =( $75642 * 4.883 + $40000 * 0.227) - $370,000
= + $8439.88
Solution 2: Profitability Index:
ETZ: Profitability Index = Net Discounted cash flow / Initial Investment
= $320159.74 / $350000 = 0.91
LKR: Profitability Index = Net Discounted cash flow / Initial Investment
= $378440 / $370000 = 1.023
Solution 3: Accounting Rate of Return:
ETZ: ACC = Net Profit / Initial Investment = $39204 / $350,000 = 11.20%
LKR: ACC = Net Profit / Initial Investment = $48642 / $370,000 = 13.15%
Solution 4: Payback Period :
ETZ: Payback Period = Initial Investment / Annual Cash flow = $350,000 / $64404 = 5.43 years
LKR: Payback Period = Initial Investment / Annual Cash flow = $370,000 / $75642 = 4.89 years
Solution 5: Going through the results in first four solutions, our conclusion is
Machine LKR would be considered as per (1) Net Present Value of +$8440 (2) Profitability Index of 1.023 and (4) Payback period of 4.89 years, but LKR have a Accounting Rate of Return of 13.15% whereas the expected rate of return is 16% so it is negative from ARR point.
Machine ETZ would not be considered as per as per any solution. Moreover the maximum payback period is 5 years, whereas ETZ's Payback period is 5.43 years. So, ETZ is totally rejected.
Finally, Machine LKR would be considered for the new product line.