Exercise 13-1 (10 minutes)

1. The payback period is determined as follows:

Unrecovered
Year Investment Cash Inflow Investment
1 $15,000 $1,000 $14,000
2 $8,000 $2,000 $20,000
3 $2,500 $17,500
4 $4,000 $13,500
5 $5,000 $8,500
6 $6,000 $2,500
7 $5,000 $0
8 $4,000 $0
9 $3,000 $0
10 $2,000 $0
The investment in the project is fully recovered in the 7th year. To be
more exact, the payback period is approximately 6.5 years.

2. Because the investment is recovered prior to the last year, the amount
of the cash inflow in the last year has no effect on the payback period.
Exercise 13-2 (10 minutes)
1.
Now 1 2 3 4 5
Purchase of $(27,000)
machine
..................................................
Reduced operating ________ $7,000 $7,000 $7,000 $7,000 $7,000
costs
..................................................
Total cash flows $(27,000) $7,000 $7,000 $7,000 $7,000 $7,000
(a)
..................................................
Discount factor (12%) 1.000 0.893 0.797 0.712 0.636 0.567
(b)
..................................................
Present value $(27,000) $6,251 $5,579 $4,984 $4,452 $3,969
(a)(b)
..................................................
Net present $(1,765)
value
..................................................

Note: The annual reduction in operating costs can also be converted to its present value using the
discount factor of 3.605 as shown in Exhibit 13B-2 in Appendix 13B.

2.

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 Total
Cash Cash
Item Flow Years Flows
Annual cost savings .. $7,000 5 $ 35,000
Initial investment ..... $(27,000) 1 (27,000)
Net cash flow ........... $ 8,000
Exercise 13-3 (30 minutes)

1. Annual savings in part-time help ............................ $3,800

Added contribution margin from expanded sales
(1,000 dozen $1.20 per dozen) ........................ 1,200
Annual cash inflows............................................... $5,000

2. Factor of the internal Investment required

=
rate of return Annual cash inflow
$18,600
= = 3.720
$5,000

Looking in Exhibit 13B-2, a factor of 3.720 falls closest to the 16% rate of return.

3. The cash flows will not be even over the six-year life of the machine because of the extra $9,125
inflow in the sixth year. Therefore, the above approach cannot be used to compute the internal rate
of return in this situation. Using trial-and-error or some other method, the internal rate of is 22%:

Now 1 2 3 4 5 6
Purchase of $(18,600)
machine
......................................
Reduced part-time $3,800 $3,800 $3,800 $3,800 $3,800 $3,800
help
......................................

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4 Managerial Accounting, 15th Edition
Added contribution 1,200 1,200 1,200 1,200 1,200 1,200
margin
......................................
Salvage value of _______ ______ ______ ______ ______ ______ 9,125
machine
......................................
Total cash flows $(18,600) $5,000 $5,000 $5,000 $5,000 $5,000 $14,125
(a)
......................................
Discount factor (22%) 1.000 0.820 0.672 0.551 0.451 0.370 0.303
(b)
......................................
Present value $(18,600) $4,100 $3,360 $2,755 $2,255 $1,850 $4,280
(a)(b)
......................................
Net present $0
value
......................................
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6 Managerial Accounting, 15th Edition
Exercise 13-6 (10 minutes)
This is a cost reduction project, so the simple rate of return would be
computed as follows:

Operating cost of old machine .................... $ 30,000

Less operating cost of new machine ........... 12,000
Less annual depreciation on the new
machine ($120,000 10 years) ............... 12,000
Annual incremental net operating income ... $ 6,000
Cost of the new machine ........................... $120,000
Scrap value of old machine ........................ 40,000
Initial investment ...................................... $ 80,000

Simple rate = Annual incremental net operating income

of return Initial investment
$6,000
= = 7.5%
$80,000
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