Sheila and The Screamers have an opportunity to invest in one of two new types of recording equipment. Type 1 requires an initial investment of $150,000 for new equipment having a four-year life and no salvage value. Type 2 requires an initial investment of $150,000 for new machinery having a five-year life and no salvage value. The two projects yield the following predicted annual results. The company uses straight-line depreciation, and cash flows occur evenly throughout each year.

Type 1 Type 2

Sales $175,000 $160,000

Expenses

Direct materials 20,000 15,000

Direct labor 32,000 33,000

Overhead including depr. 97,500 90,000

Selling and admin. expenses 9,000 9,000

Total expenses 158,500 147,000

Pretax income 16,500 13,000

Income taxes (40%) 6,600 5,200

Net income $ 9,900 $ 7,800

Required

1. Compute the annual expected net cash flows for each type of equipment.
2. Determine the payback period for each type of equipment.
3. Compute the accounting rate of return for each type of equipment.
4. Determine the net present value for each type of equipment using 6% as the discount rate. For part (4) only, assume that cash flows occur at each year-end.
5. Identify the type of equipment you would recommend to management and explain your choice using the results of our calculations in requirements 2, 3, and 4.