Capital Budgeting
Carry-Along Is Debating Whether or Not to Invest

question 1

Short Answer

Capital budgeting
Carry-Along is debating whether or not to invest in new equipment to manufacture a line of high-quality luggage. The new equipment would cost $850,000, with an estimated four-year life and no salvage value. The estimated annual operating results with the new equipment are as follows:
All revenue from the new luggage line and all expenses (except depreciation) will be received or paid in cash in the same period as recognized for accounting purposes. You are to compute the following for the investment in the new equipment to produce the new luggage line:
(a) Annual cash flow: $___________
(b) Payback period: __________ years
(c) Return on average investment: ___________%
(d) Total present value of the expected future annual cash flows, discounted at an annual rate of 12% (an annuity table shows that the present value of $1 received annually for four years discounted at 12% is 3.037): $___________
(e) Net present value of the proposed investment: $___________
$\begin{array}{l}\text { Revenue from sales of new luggage line }&&\$925,000\\\text { Expenses other than depreciation } & \$ 625,000 \\\text { Depreciation (straight-line basis) } & 250,000&(875,000)\\\text { Increase in net income from the new line }&&\$50,000\end{array}$

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Definitions:

Sunk Costs

Costs that have already been incurred and cannot be recovered or refunded, and should not influence current or future decisions.

Variable Costs

Costs that change in proportion to the level of production or service activity.

Fixed Costs

Expenses that remain constant regardless of the amount of production, like lease payments or wages.

Marginal Costs

The cost of producing one additional unit of a product, which varies depending on the level of production.