CH 25 PROBLEM SET B

Problem 25-1B (50 minutes)

Part 1
Annual straight-line depreciation =
$70,000

$300,000 - $20,000

4 years

Part 2
Net
Income

Net Cash
Flow

Expected annual sales of new product........................

$1,150,000 $1,150,000
Expected annual costs of new product
Direct materials........................................................... 300,000

300,000

Direct labor.................................................................. 420,000

420,000

Overhead excluding depr. on new asset................... 210,000

210,000

Depreciation on new asset.........................................

70,000

Selling and administrative expenses........................ 100,000

Income before taxes.......................................................

50,000

Income taxes (30%)........................................................

15,000

Net income......................................................................$

35,000

Net cash flow*.................................................................

*Alternatively, annual net cash flow can be computed as:
Net income + Depreciation = $35,000 + $70,000 = $105,000

100,000
15,000
$ 105,000

Problem 25-1B (Continued)

Part 3
Payback Period =

$300,000
$105,000

= 2.86 years

Part 4
Accounting rate of return =

$35,000
$160,000*

= 21.88%

*Average investment
Asset cost.............................................................$300,000
Final years book value........................................ 20,000
Sum........................................................................$320,000
Average (Sum /2)..................................................$160,000

Part 5
Present Value of Net Cash Flows

Year 1...............................................................
Year 2...............................................................
Year 3...............................................................
Year 4*.............................................................

Present
Net Cash Value of
Flows
1 at 7%
$105,000
0.9346
105,000
0.8734
105,000
0.8163
125,000
0.7629

Totals............................................................... $440,000

Present
Value of
Net Cash
Flows
$ 98,133
91,707
85,712
95,363
$ 370,915

Amount invested............................................

(300,000)

Net present value...........................................

$ 70,915

* Year 4s cash flow includes the $20,000 salvage value.

Problem 25-2B (55 minutes)

Part 1
PROJECT A
Net income...............................................................................................$39,900
Depreciation expense*............................................................................ 60,000
Net cash flow...........................................................................................$99,900
*Annual depreciation =

$240,000 - $0
4 years

= $60,000

PROJECT B
Net income...............................................................................................
$ 25,900
Depreciation expense*............................................................................ 80,000
Net cash flow...........................................................................................
$105,900
*Annual depreciation =

$240,000 - $0
3 years

= $80,000

Part 2
PROJECT A
Payback Period =

$240,000
$ 99,900

= 2.4 years

$240,000
$105,900

= 2.3 years

PROJECT B
Payback Period =

Problem 25-2B (Continued)

Part 3

PROJECT A

Accounting rate of return =

$39,900
$120,000*

= 33.3%

*Average investment
Asset cost.................................................. $240,000
Average (Cost/2)........................................ $120,000

PROJECT B

Accounting rate of return =

$25,900
$120,000*

= 21.6%

*Average investment
Asset cost.................................................. $240,000
Average (Cost/2)........................................ $120,000

Problem 25-2B (Continued)

Part 4
PROJECT A
Present Value of Net Cash Flows

Net Cash
Flows

Present
Value of
1 at 8%
Annuity

Present
Value of
Net Cash
Flows

Years 1-4........................................................ $99,900

3.3121

$330,879

Amount invested..........................................

(240,000)

Net present value..........................................

$ 90,879

PROJECT B
Present Value of Net Cash Flows

Net Cash
Flows

Present
Value of
1 at 8%
Annuity

Present
Value of
Net Cash
Flows

Years 1-3........................................................ $105,900

2.5771

$272,915

Amount invested..........................................

(240,000)

Net present value..........................................

$ 32,915

Part 5
Recommendation to management is to pursue Project A. This is
because although both projects have a positive net present value,
Project A has a higher positive net present value. We might also
note that the accounting rate of return is also higher for Project A
compared with Project B. Project B has a slightly lower payback
period, thereby reducing the risk of that project slightly, but the lower
risk is insufficient to make up for the extra years income from
Project A.

Problem 25-3B (60 minutes)

Part 1
RESULTS USING STRAIGHT-LINE DEPRECIATION
(a)
Income
Before
Deprec.

(b)
StraightLine
Deprec.

(c)
Taxable
Income
(a) - (b)

(d)
40%
Income
Taxes

(e)
Net Cash
Flows
(a) - (d)

Year 1.............................
$12,000

$3,000

$ 9,000

$3,600

$8,400

Year 2.............................
12,000

6,000

6,000

2,400

9,600

Year 3.............................
12,000

6,000

6,000

2,400

9,600

Year 4.............................
12,000

6,000

6,000

2,400

9,600

Year 5.............................
12,000

6,000

6,000

2,400

9,600

Year 6.............................
12,000

3,000

9,000

3,600

8,400

Part 2
RESULTS USING MACRS DEPRECIATION
(a)
Income
Before
Deprec.

(b)
MACRS
Deprec.

(c)
Taxable
Income
(a) - (b)

(d)
40%
Income
Taxes

(e)
Net Cash
Flows
(a) - (d)

Year 1.............................
$12,000

$6,000

$ 6,000

$2,400

$ 9,600

Year 2.............................
12,000

9,600

2,400

960

11,040

Year 3.............................
12,000

5,760

6,240

2,496

9,504

Year 4.............................
12,000

3,456

8,544

3,418

8,582

Year 5.............................
12,000

3,456

8,544

3,418

8,582

Year 6.............................
12,000

1,728

10,272

4,109

7,891

Problem 25-3B (Continued)

Part 3
NET PRESENT VALUE OF ASSET USING STRAIGHT-LINE DEPRECIATION
Net Cash
Flows

Year 1............................................................ $ 8,400

Year 2............................................................
9,600
Year 3............................................................
9,600
Year 4............................................................
9,600
Year 5............................................................
9,600
Year 6............................................................
8,400
Totals............................................................ $55,200
Amount invested.........................................

Present
Value of
1 at 10%

Present
Value of Net
Cash Flows

0.9091
0.8264
0.7513
0.6830
0.6209
0.5645

$ 7,636
7,933
7,212
6,557
5,961
4,742
$40,041
(30,000)

Net present value........................................

$10,041

Part 4
NET PRESENT VALUE OF ASSET USING MACRS DEPRECIATION
Net Cash
Flows

Year 1............................................................ $ 9,600

Year 2............................................................ 11,040
Year 3............................................................
9,504
Year 4............................................................
8,582
Year 5............................................................
8,582
Year 6............................................................
7,891
Totals............................................................ $55,199
Amount invested.........................................
Net present value........................................

Present
Value of
1 at 10%

Present
Value of Net
Cash Flows

0.9091
0.8264
0.7513
0.6830
0.6209
0.5645

$ 8,727
9,123
7,140
5,862
5,329
4,454
$40,635
(30,000)
$10,635

Part 5
Analysis: The net present value using MACRS depreciation is greater
than the net present value using straight-line depreciation because the
cash flows are larger in the earlier years of the assets life under MACRS
depreciation. They are larger because the depreciation deductions are
larger, resulting in less income taxes paid in the earlier years.

Problem 25-4B (45 minutes)

WINDMIRE COMPANY
COMPARATIVE INCOME STATEMENTS
(1)

Normal
Volume

Sales............................................................$1,200,000

(2)

New
Business

(3)

Combined

$172,000 $1,372,000

Costs and expenses

Direct materials........................................

384,000

64,000

448,000

Direct labor...............................................

96,000

24,000

120,000

Overhead...................................................

288,000

36,000

324,000

Selling expenses......................................

120,000

Administrative expenses.........................

80,000

4,000

84,000

Total costs and expenses..........................

968,000

128,000

1,096,000

Operating income.......................................$ 232,000

$ 44,000

$ 276,000

120,000

Supporting computations
Normal direct material cost......................................................
$384,000
Units of output...........................................................................
300,000
Cost per unit..............................................................................
$
1.28
New business volume...............................................................
50,000
New business direct material cost...........................................
$ 64,000
Normal direct labor cost...........................................................
$ 96,000
Units of output...........................................................................
300,000
Cost per unit..............................................................................
$
0.32
Overtime per unit (50%)............................................................ 0.16
New business direct labor cost per unit.................................
$
0.48
New business volume...............................................................
50,000
New business direct labor cost................................................
$ 24,000
Total overhead...........................................................................
$288,000
Fixed overhead (25%)................................................................
72,000
Variable overhead......................................................................
$216,000
Units of output...........................................................................
300,000
Cost per unit..............................................................................
$ 0.72
New business volume...............................................................
50,000
New business variable overhead cost.....................................
$ 36,000

Problem 25-5B (55 minutes)

Part 1
Product R

Product T

Selling price per unit......................................................

$ 60

$ 80

Variable costs per unit...................................................

20

45

Contribution margin per unit........................................

$ 40

$ 35

Machine hours to produce 1 unit.................................

0.4

1.0

Contribution per machine hour

(or contribution/[hours per unit])..............................

$100

$ 35

Part 2
Sales Mix Recommendation To the extent allowed by production and
market constraints, the company should produce as much of Product
R as possible. With a single shift yielding 176 hours per month (8 x
22), the company can produce these units of Product R:
Maximum output of R =

176 hrs. per mo.

0.4 hrs. per unit

= 440 units per month

Contribution Margin at Recommended Sales Mix

Contribution margin = 440 units x $40 per unit = $17,600 per month

Problem 25-5B (Continued)

Part 3
Sales Mix Recommendation with Second Shift If the second shift is
added, the maximum possible output of R will double:
Maximum possible output of R =
per mo.

352 hrs. per mo.

0.4 hrs. per unit

= 880 units

However, this level of output exceeds the companys market

constraint of 550 units of Product R per month. This means the
company should produce 550 units of Product R, and commit the
remainder of the productive capacity to Product T. This is computed
as follows:
Units of Product R............................................................= 550 units per month
Hours per unit................................................................... 0.4
Hours used for Product R................................................ 220 hours
Hours available for Product T (352 hrs - 220 hrs).................. 132 hours

The output of Product T with 132 production hours is

Units of Product T

132 hrs. per mo.

1.0 hrs. per unit

= 132 units per month

Contribution Margin at This Sales Mix

Units Contr./unit
From R................................................................... 550
$40
From T................................................................... 132
35
Less extra shift costs..........................................
Total contribution margin....................................

Total
$22,000
4,620
(3,250)
$23,370

Management decision
This amount of $23,370 exceeds the
contribution margin of $17,600 generated by one shift alone (see part
2). Therefore, management should add the second shift.

Problem 25-5B (Continued)

Part 4
Sales Mix Recommendation By incurring additional marketing cost,
the company can relax the market constraint for sales of Product R
up to the point where 675 units can be sold. This means the
company can produce 675 units of Product R, and commit the
remainder of its productive capacity to Product T.
These
computations are:
Units of Product R............................................................= 675 units per month
Hours per unit................................................................... 0.4
Hours used for Product R................................................ 270 hours
Hours available for Product T
(352 hrs less 270 hrs).................................................... 82 hours

The output of Product T with 82 production hours is

Units of Product T

82 hrs. per mo.

1.0 hr. per unit

= 82 units per month

Contribution Margin with This Sales Mix

Units Contr./unit
From R................................................................... 675
$40
From T................................................................... 82
35
Less extra shift costs..........................................
Less extra marketing costs.................................
Total contribution margin....................................

Total
$27,000
2,870
(3,250)
(4,500)
$22,120

Management decision
This amount of $22,120 is less than the
contribution margin of $23,370 generated under the existing market
constraint (see part 3). Therefore, management should not undertake
this marketing strategy.

Problem 25-6B (60 minutes)

Part 1
ESME COMPANY
Analysis of Expenses under Elimination of Department Z
Total
Eliminated
Expenses Expenses

Cost of goods sold...............................................

$586,400

Continuing
Expenses

$125,100

$461,300

3,000
1,400

27,000
5,600
21,000

46,800

46,800

Direct expenses
Advertising..........................................................
30,000
Store supplies used...........................................
7,000
Depreciation of store equip...............................
21,000
Allocated expenses
Sales salaries*....................................................
93,600
Rent expense......................................................
27,600
Bad debts expense.............................................
25,000

27,600
4,000

Office salary*......................................................
26,000

21,000
26,000

Insurance expense*............................................
5,600

910

4,690

Miscellaneous office expenses*.......................

4,200

750

3,450

Total expenses......................................................
$826,400

$181,960

$644,440

Computation Notes
Closing Department Z will eliminate 65% of its
insurance expense and 30% of its miscellaneous office expense. Sales
salaries will be reduced by the amounts paid to the two clerks who will not
be replaced. The office salary will not be eliminated, but it will be
reclassified so that one-half will be reported as sales salary and one-half as
office salary.

Problem 25-6B (Continued)

Part 2
ESME COMPANY
Forecasted Annual Income Statement
Under Plan to Eliminate Department Z
Sales......................................................................................................$700,000
Cost of goods sold............................................................................... 461,300
Gross profit from sales........................................................................ 238,700
Operating expenses
Advertising..........................................................................................

27,000

Store supplies used...........................................................................

5,600

Depreciation of store equipment......................................................

21,000

Sales salaries......................................................................................

59,800*

Rent expense......................................................................................

27,600

Bad debts expense.............................................................................

21,000

Office salary........................................................................................

13,000*

Insurance expense.............................................................................

4,690

Miscellaneous office expenses.........................................................

3,450

Total operating expenses.................................................................... 183,140

Net income............................................................................................$ 55,560

* Office salary reassignment

Total
Sales
Salaries Salaries
Sales clerks........................................................................
$46,800 $46,800
Office clerk.........................................................................
26,000
Reassign office clerk to sales...........................................
0
13,000
Revised salaries.................................................................
$72,800 $59,800

Office
Salary
$26,000
(13,000)
$13,000

Problem 25-6B (Continued)

Part 3
ESME COMPANY
Reconciliation of Combined Income with Forecasted Income
Combined net income ............................................................................
$ 48,600
Less Dept. Z's lost sales........................................................................
(175,000)
Plus Dept. Zs eliminated expenses......................................................
181,960
Forecasted net income...........................................................................
$ 55,560

ANALYSIS
Department Z's avoidable expenses of $181,960 are $6,960 greater
than its revenues of $175,000. This means the company's annual net
income would be $6,960 higher from eliminating Department Z. This
analysis suggests management should probably go ahead with the
elimination of the department as planned.