Busy Beaver Corp. is interested in reviewing its method of evaluating capital expenditure proposals using the accounting

Question:

Busy Beaver Corp. is interested in reviewing its method of evaluating capital expenditure proposals using the accounting rate of return method. A recent proposal involved a $50,000 investment in a machine that had an estimated useful life of five years and an estimated salvage value of $10,000. The machine was expected to increase net income (and cash flows) before depreciation expense by $15,000 per year. The criteria for approving a new investment are that it have a rate of return of 16% and a payback period of three years or less.

Required:

a. Calculate the accounting rate of return on this investment for the first year. Assume straight-line depreciation. Based on this analysis, would the investment be made? Explain your answer.

b. Calculate the payback period for this investment. Based on this analysis, would the investment be made? Explain your answer.

c. Calculate the net present value of this investment using a cost of capital of 16%. Based on this analysis, would the investment be made? Explain your answer.

d. What recommendation would you make to the management of Busy Beaver Corp. about evaluating capital expenditure proposals? Support your recommendation with the appropriate rationale.

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... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... 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,...