Marc Corporation wants to purchase a new machine for $400,000.Management predicts that the machine can produce sales of $275,000 each year for the next 5 years.Expenses are expected to include direct materials,direct labor,and factory overhead (excluding depreciation)totaling $80,000 per year.The company uses MACRS for depreciation.The machine is considered as a 3-year property and is not expected to have any significant residual at the end of its useful years.Marc's income tax rate is 40%.Management requires a minimum of 10% return on all investments.A partial MACRS depreciation table is reproduced below.

Question

Quizplus · Accepted Answer

Required:
1.What is the payback period for the new machine (rounded to the nearest tenth of a year)? Assume for purposes of this calculation that the cash inflows occur evenly throughout the year.
2.What is the book (accounting)rate of return (rounded to the nearest whole percent)based on the initial investment and on average after-tax income over the five-year period?
3.What is the book (accounting)rate of return,rounded to the nearest whole percent,based on the average investment,where the latter is determined as a simple average of beginning-of-project and end-of-project book value of the asset?
Please see Feedback for answers.
 Feedback: Question 1:
1.Original investment outlay (year 0)= $400,000
2.Remaining MACRS depreciation charges:
a.Year 2 = 44.45% x $400,000 = $177,800
b.Year 3 = 14.81% x $400,000 = $59,240
c.Year 4 = 7.41% x $400,000 = $29,640
d.Year 5 = $0
3.Pre-tax incomes,Years 2 through 5:
a.Year 2 = $275,000 - $80,000 - $177,800 = $17,200
b.Year 3 = $275,000 - $80,000 - $59,240 = $135,760
c.Year 4 = $275,000 - $80,000 - $29,640 = $165,360
d.Year 5 = $275,000 - $80,000 - $0 = $195,000
4.After-tax incomes,Years 2 through 5:
a.Year 2 = $17,200 x (1 - 0.40)= $10,320
b.Year 3 = $135,760 x (1 - 0.40)= $81,456
c.Year 4 = $165,360 x (1 - 0.40)= $99,216
d.Year 5 = $195,000 x (1 - 0.40)= $117,000
5.After-tax cash flows,Years 2 through 5:
a.Year 2 = $10,320 + $177,800 = $188,120
b.Year 3 = $81,456 + $59,240 = $140,696
c.Year 4 = $99,216 + $29,640 = $128,856
d.Year 5 = $117,000 + $0 = $117,000
6.Cumulative after-tax cash inflows:
a.Year 1 = $170,328
b.Year 2 = $170,328 + $188,120 = $358,448
c.Year 3 = $358,448 + $140,696 = $499,144
7.Therefore,the payback period = 2 years + ($400,000 - $358,448)/$140,696 = 2.3 years
Question 2:
1.Average annual after-tax profit = ($37,008 + $10,320 + $81,456 + $99,216 + $117,000)/5 years = $69,000
2.Initial investment = $400,000
3.ARR = $69,000/$400,000 = 17.25% (17%,rounded)
Question 3:
1.Average after-tax income = ($37,008 + $10,320 + $81,456 + $99,216 + $117,000)/5 years = $69,000
2.Average investment = (Initial outlay + end-of-project book value)/2 = ($400,000 + $0)/2 = $200,000
3.ARR = $69,000/$200,000 = 34.5% (35%,rounded)

Marc Corporation Wants to Purchase a New Machine for $400,000