Simple Rate of Return and Payback Analysis

Simple Rate of Return and Payback Analysis of Two Machines (LO3, LO4)

Blue Ridge Furniture is considering the purchase of two different items of equipment, as described below:

1. Machine A. A compacting machine has just come onto the market that would permit Blue Ridge Furniture to compress sawdust into various shelving products. At present the sawdust is disposed of as a waste product. The following information is available about the machine:

a. The machine would cost $780,000 and would have a 25% salvage value at the end of its 10-year useful life. The company uses straight-line depreciation and considers salvage value in computing depreciation deductions.
b. The shelving products manufactured from use of the machine would generate revenues of $350,000 per year. Variable manufacturing costs would be 20% of sales.
c. Fixed expenses associated with the new shelving products would be (per year): advertising, $42,000; salaries, $86,000, utilities, $9,000; and insurance, $13,000.

2. Machine B. A second machine has come onto the market that would allow Blue Ridge Furniture to automatic a sanding process that is now done largely by hand. The following information is available:

a. The new sanding machine would cost $220,000 and would have no salvage value at the end of its 10-year useful life. The company would use straight-line depreciation on the new machine.
b. Several old pieces of sanding equipment that are fully depreciated would be disposed of at a scrap value of $7,200.
c. The new sanding machine would provide substantial annual savings in cash operating costs. It would require an operator at an annual salary of $26,000 and $3,000 in annual maintenance costs. The current, hand-operated sanding procedure costs the company $85,000 per year in total.

Blue Ridge Furniture requires a simple rate of return of 16% on all equipment purchases. Also, the company will not purchase equipment unless the equipment has a payback period of 4 years or less.

Solve:
1. For machine A.
a. Prepare an income statement showing the expected net operating income each year from the new shelving products. Use the contribution format.
b. Compute the simple rate of return
c. Compute the payback period.

2. For machine B.
a. Compute the simple rate of return.
b. Compute the payback period.

3. According to the company's criteria, which machine, if either, should the company purchase?

1. Listed below are the changes that have taken place in Kit Corporation's balance sheet accounts as a result of the past year's activities:

Debit Balance Accounts Net Increase (Decrease)
Cash $30,000
Accounts Receivable 20,000
Inventory (60,000)
Pre-paid Expenses 10,000
Long-Term Investments 50,000
Plant and Equipment 120,000
Net Increase $110,000

Credit Balance Accounts Net Increase (Decrease)
Accumulated Depreciation $40,000
Accounts Payable 30,000
Accrued Liabilities 10,000
Taxes Payable 10,000
Bonds Payable (40,000)
Deferred Income Taxes (5,000)
Common Stock 20,000
Retained Earnings 45,000
Net increase $110,000

The following additional information is available about last year's activities:
a. The company sold equipment during the year for $40,000. The equipment had cost the company $120,000 when purchased, and it had $70,000 in accumulated depreciation at the time of sale.
b. Net income for the year was $_________.
c. The balance in the Cash account at the beginning of the year was $100,000; the balance at the end of the year was $___________.
d. The company declared and paid $35,000 in cash divided during the year.
e. Long-term investments that had cost $60,000 were sold during the year for $80,000.
f. The beginning and ending balances in the Plant and Equipment and Accumulated Depreciation accounts for the past year are given below:

Ending Beginning
Plant and Equipment $620,000 $500,000
Accumulated Depreciation $240,000 $200,000

g. If data are not given explaining the change in an account, make the most reasonable assumption as to the cause of the change.

Solve using the indirect method; prepare a statement of cash flows for the past year.

See attached file for full problem description.