Tanner Corporation is considering the acquisition of a new machine that is expected to produce annual savings in cash operating costs of $30,000 before income taxes. The machine costs $100,000, has a useful life of five years, and no salvage value. Tanner uses straight-line depreciation on all assets, is subject to a 30% income tax rate, and has an after-tax hurdle rate of 8%.YearFV of $1 at 8%FV of an ordinary annuity at 8% PV of $1 at 8%PV of an ordinary annuity at 8% 11.0801.0000.9260.92621.1662.0800.8571.78331.2603.2460.7942.57741.3614.5060.7353.31251.4695.8670.6813.99361.5877.3360.6304.623Required:A. Compute the machine's accounting rate of return on the initial investment.B. Compute the machine's net present value.
What will be an ideal response?
A. Average income: ($30,000 ? $20,000) × 0.70 = $7,000
Accounting rate of return: $7,000 ÷ $100,000 = 7%
B.
| Initial investment | $(100,000) × 1.0 | $(100,000) |
| Savings in operating costs | $21,000 × 3.993 | 83,853 |
| Depreciation tax savings | See schedule below | 23,070 |
| Net present value | ? | $6,923 |
Depreciation tax savings:
Year 1: 10,000 × .3 = 3,000 × .926 = 2,778
Year 2: 20,000 × .3 = 6,000 × .857 = 5,142
Year 3: 20,000 × .3 = 6,000 × .794 = 4,764
Year 4: 20,000 × .3 = 6,000 × .735 = 4,410
Year 5: 20,000 × .3 = 6,000 × .681 = 4,086
Year 6: 10,000 × .3 = 3,000 × .630 = 1,890
TOTAL $23,070
NPV = $6,923
The present value of the cash inflows from cost and tax savings = $106,923.
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