Question
Crichton Publications uses the accounting rate of return method to evaluate proposed capital investments. The company's desired rate of return is 15.0%. The project
Crichton Publications uses the accounting rate of return method to evaluate proposed capital investments. The company's desired rate of return is 15.0%. The project being evaluated involves a new product that will have a three-year life. The investment required is $330,000, which consists of a $275,000 machine, and inventories and accounts receivable totaling $55,000. The machine will have a useful life of three years and a salvage value of $157,500. The salvage value will be received during the fourth year, and the inventories and accounts receivable related to the product also will be converted back to cash in the fourth year. Accrual accounting net income from the product will be $90,000 per year, before depreciation expense, for each of the three years. Because of the time lag between selling the product and collecting the accounts receivable, cash flows from the product will be as follows: Use Table 6-4. Note: Use appropriate factor(s) from the tables provided. Round the PV factors to 4 decimals. 1st year 2nd year 3rd year 4th year Required: $ 45,000 75,000 90,000 63,000 a. Calculate the accounting rate of return for the first year of the product. Assume straight-line depreciation. Based on this analysis, would the investment be made? Note: Do not round intermediate calculations. Round your answer to 2 decimal places. b. Calculate the net present value of the product using a discount rate of 15.0% and assuming that cash flows occur at the end of the respective years. Based on this analysis, would the investment be made? Note: Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. c. Which of these two analytical approaches is the more appropriate to use? a. Accounting rate of return a. Based on the analysis, would the investment be made? b. Net present value b. Based on the analysis, would the investment be made? c. The best technique to use is %
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