West Steel Company decided to spend $200,000 to purchase new state-of-the-art equipment for its manufacturing plant. The

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West Steel Company decided to spend $200,000 to purchase new state-of-the-art equipment for its manufacturing plant. The equipment has a five-year useful life and a salvage value of $50,000. It is expected to generate additional cash revenue of $80,000 per year. West Steel’s required rate of return is 10 percent; its effective income tax rate is 25 percent.

Required
Round financial figures to the nearest whole dollar and other figures to two decimal points.
a. Determine the net present value and the present value index of the investment, assuming that West Steel uses straight-line depreciation for financial and income tax reporting.
b. Determine the net present value and the present value index of the investment, assuming that West Steel uses double-declining-balance depreciation for financial and income tax reporting.
c. Why are there differences in the net present values computed in Requirements a and b?
d. Determine the payback period and unadjusted rate of return (use average investment), assuming that West Steel uses straight-line depreciation.
e. Determine the payback period and unadjusted rate of return (use average investment), assuming that West Steel uses double-declining-balance depreciation. (Note: Use average annual cash flow when computing the payback period and average annual income when computing the unadjusted rate of return.)
f. Why are there no differences in the payback period or unadjusted rate of return computed in Requirements d and e?

Net Present Value
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...
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,...
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Fundamental Managerial Accounting Concepts

ISBN: 978-0078025655

7th edition

Authors: Thomas Edmonds, Christopher Edmonds, Bor Yi Tsay, Philip Old

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