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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
BuyFindarrow_forward

Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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Basic Net Present Value Analysis

Jonathan Butler, process engineer, knows that the acceptance of a new process design will depend on its economic feasibility. The new process is designed to improve environmental performance. On the negative side, the process design requires new equipment and an infusion of working capital. The equipment will cost $1,200,000, and its cash operating expenses will total $270,000 per year. The equipment will last for 7 years but will need a major overhaul costing $120,000 at the end of the fifth year. At the end of 7 years, the equipment will be sold for $96,000. An increase in working capital totaling $120,000 will also be needed at the beginning. This will be recovered at the end of the 7 years.

On the positive side, Jonathan estimates that the new process will save $400,000 per year in environmental costs (fines and cleanup costs avoided). The cost of capital is 12%.

Required:

  1. 1. Prepare a schedule of cash flows for the proposed project. (Note: Assume that there are no income taxes.)
  2. 2. Compute the NPV of the project. Should the new process design be accepted?

1.

To determine

Construct a schedule of cash flows.

Explanation

Schedule of the Projected Cash Flows:

A schedule that shows the projected inflows and outflows of cash for an upcoming period often a year is known as a schedule of the projected cash flows. These projected cash flows help to make the capital investment decision.

Schedule of the projected cash flows:

YearItemCash flow($)Cash flow($)
0Equipment (1,200,000)
 

2.

To determine

Compute NPV. Also recommend that the new design should be accepted or not.

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