Reference no: EM132418664

Problem: Sheila and The Screamers have an opportunity to invest in one of two new types of recording equipment. Type 1 requires an initial investment of $150,000 for new equipment having a four-year life and no salvage value. Type 2 requires an initial investment of $150,000 for new machinery having a five-year life and no salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation, and cash flows occur evenly throughout each year.

                            Type 1     Type 2

Sales                                            $175,000 $160,000

Expenses

  Direct materials                             20,000     15,000

  Direct labor                                    32,000     33,000

  Overhead including              97,500     90,000

  Selling and admin.           9,000       9,000

Total expenses                              158,500   147,000

Pretax income                                 16,500    13,000

Income taxes (40%)                          6,600       5,200

Net income                                     $ 9,900   $ 7,800

Required

1. Compute the annual expected net cash flows for each type of equipment.

2. Determine the payback period for each type of equipment.

3. Compute the accounting rate of return for each type of equipment.

4. Determine the net present value each type of equipment using 6% as the discount rate. (4) flows occur each year-end.

5. Identify the type of equipment you would recommend to and explain your choice using the results of our calculations in requirements 2, 3, and 4.