| Luang Company is considering the purchase of a new machine. Its invoice price is $122,000, freight | | | |
| charges are estimated to be $3,000, and installation costs are expected to be $5,000. Salvage value of the new | | |
| machine is expected to be zero after a useful life of 4 years. Existing equipment could be retained and used for an | |
| additional 4 years if the new machine is not purchased. At that time, the salvage value of the equipment would be | |
| zero. If the new machine is purchased now, the existing machine would be scrapped. Luangs accountant, Lisa | | |
| Hsung, has accumulated the following data regarding annual sales and expenses with and without the new | | |
| machine. | | | | | | | | | |
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| 1. Without the new machine, Luang can sell 10,000 units of product annually at a per unit selling price of | | |
| $100. If the new unit is purchased, the number of units produced and sold would increase by 25%, and the selling | |
| price would remain the same. | | | | | | | |
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| 2. The new machine is faster than the old machine, and it is more efficient in its usage of materials. | | | |
| With the old machine the gross profit rate will be 28.5% of sales, whereas the rate will be 30% of sales with the new machine. | |
| (Note: These gross profit rates do not include depreciation on the machines. For purposes of determining net income, | |
| treat depreciation expense as a separate line item.) | | | | | | |
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| 3. Annual selling expenses are $160,000 with the current equipment. Because the new equipment would produce a greater | |
| number of units to be sold, annual selling expenses are expected to increase by 10% if it is purchased. | | |
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| 4. Annual administrative expenses are expected to be $100,000 with the old machine, and $112,000 with the new machine. | |
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| 5. The current book value of the existing machine is $40,000. Luang uses straight-line depreciation. | | | |
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| 6. Luangs management has a required rate of return of 15% on its investment and a cash payback period of no more than 3 years. |
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| Instructions: (Ignore income tax effects.) | | | | | | |
| (a) Calculate the annual rate of return for the new machine. (Round to two decimals.) | | | | |
| (b) Compute the cash payback period for the new machine. (Round to two decimals.) | | | | |
| (c) Compute the net present value of the new machine. (Round to the nearest dollar.) | | | | |
| (d) On the basis of the foregoing data, would you recommend that Luang buy the machine? Why? | | | |
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