Question

Tanner Corporation is considering the acquisition of a new machine that is expected to produce annual savings in cash operating costs of $74,000 before income taxes. The machine costs $260,000, has a useful life of five years, and no salvage value, Tanner uses straight-line depreclation on all assets, is subject to a 35% income tax rate, and has an after-tax hurdle rate of 8%. Required: A. Compute the machine's accounting rate of return on the initial investment. B. Compute the machine's net present value. (For all requirements, Do not round intermediate calculations. Round final answers to whole number.)

Answer 1

To compute the machine's accounting rate of return (ARR) on the initial investment, we need to calculate the average annual after-tax net income over the useful life of the machine.

Step 1: Calculate the annual after-tax net income:

Annual savings in cash operating costs = $74,000

Income tax rate = 35%

Before-tax annual net income = Annual savings - Depreciation expense

Since the machine has no salvage value, the depreciation expense per year is ($260,000 / 5) = $52,000

Before-tax annual net income = $74,000 - $52,000 = $22,000

After-tax annual net income = Before-tax annual net income * (1 - Tax rate)

After-tax annual net income = $22,000 * (1 - 0.35) = $14,300

Step 2: Calculate the average annual after-tax net income:

Average annual after-tax net income = After-tax annual net income / Useful life

Average annual after-tax net income = $14,300 / 5 = $2,860

Step 3: Calculate the accounting rate of return (ARR):

ARR = Average annual after-tax net income / Initial investment * 100%

Initial investment = $260,000

ARR = $2,860 / $260,000 * 100%

ARR ≈ 1.10%

Therefore, the machine's accounting rate of return on the initial investment is approximately 1.10%.

To compute the machine's net present value (NPV), we need to discount the expected cash flows using the after-tax hurdle rate.

Step 1: Calculate the present value of the annual after-tax net income:

Discount rate = After-tax hurdle rate = 8%

Present value factor = 1 / (1 + Discount rate)

Year 1: Present value of $2,860 = $2,860 * Present value factor

Year 2: Present value of $2,860 = $2,860 * Present value factor^2

Year 3: Present value of $2,860 = $2,860 * Present value factor^3

Year 4: Present value of $2,860 = $2,860 * Present value factor^4

Year 5: Present value of $2,860 = $2,860 * Present value factor^5

Step 2: Calculate the net present value (NPV):

NPV = Present value of cash inflows - Initial investment

NPV = (Present value of Year 1 cash flow + Present value of Year 2 cash flow + ... + Present value of Year 5 cash flow) - Initial investment

Calculate the present value factor for each year and substitute the values into the formula to compute the NPV.

Note: The calculations involve the discounting of cash flows, which requires more precise calculations. Rounding to whole numbers at intermediate steps may result in inaccurate final answers.

Step-by-step explanation:

Answer 2

Accounting Rate of Return = Net Operating Income / Initial Investment Operating Income before Tax = Annual Savings - Depreciaticate