Harmony Company has a number of potential capital investments. Because these projects vary in nature, initial investment,
Question:
Harmony Company has a number of potential capital investments. Because these projects vary in nature, initial investment, and time horizon, Harmony’s management is finding it difficult to compare them.
Project 1: Retooling Manufacturing Facility
This project would require an initial investment of $2,700,000. It would generate $975,000 in additional cash flow each year. The new machinery has a useful life of seven years and a salvage value of $600,000.
Project 2: Purchase Patent for New Product
The patent would cost $8,200,000, which would be fully amortized over 10 years. Production of this product would generate $1,650,000 additional annual net income for Harmony.
Project 3: Purchase a New Fleet of Delivery Vans
Harmony could purchase 10 new delivery vans at a cost of $25,000 each. The fleet would have a useful life of 10 years, and each van would have a salvage value of $2,500. Purchasing the fleet would allow Harmony to expand its delivery area resulting in $30,000 of additional net income per year.
Required:
1. Determine each project’s accounting rate of return and compare the projects.
2. Determine each project’s payback period and compare the projects.
3. Using a discount rate of 10 percent, calculate the net present value of each project.
4. Determine the profitability index of each project and prioritize the projects for Harmony.
What is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at... Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal... Payback Period
Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them,...
Step by Step Answer:
Managerial Accounting
ISBN: 978-0078025518
2nd edition
Authors: Stacey Whitecotton, Robert Libby, Fred Phillips