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The Terme Corporation is contemplating the purchase of new equipment,which may potentially increase revenues by 25%.Currently,sales are $750,000 per year and variable costs are 55% of sales.The equipment is expected to last for 5 years with no residual value.The cash outflow expected at the beginning of the year is $ 357,500.
-Ignoring income taxes,what is the estimated annual net operating income increase/decrease?

Question

Quizplus · Accepted Answer

First, we need to calculate the current annual net operating income (NOI).
Current Sales = $750,000
Variable Costs = 55% of sales = 55% * $750,000 = $412,500
Current NOI = Sales - Variable Costs = $750,000 - $412,500 = $337,500

Then, we need to calculate the potential annual NOI after the purchase of the equipment.
Potential Sales = 25% increase = 1.25 * $750,000 = $937,500
Variable Costs = 55% of potential sales = 55% * $937,500 = $515,625
Annual Depreciation = Cash outflow / years of expected life = $357,500 / 5 years = $71,500
Potential NOI = Potential Sales - Variable Costs - Annual Depreciation = $937,500 - $515,625 - $71,500 = $350,375

Finally, we can calculate the estimated annual NOI increase/decrease.
Estimated annual NOI increase/decrease = Potential NOI - Current NOI = $350,375 - $337,500 = $12,875

Therefore, the answer is B) $12,875 increase.

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