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1. Toying With Nature wants to take advantage of children's current fascination with dinosaurs by adding several scale-model dinosaurs to its existing product line. Annual sales of the dinosaurs are estimated at 80,000 units at a price of $6 per unit. Variable manufacturing costs are estimated at $2.50 per unit, incremental fixed manufacturing costs (excluding depreciation) at $43,000 annually, and additional selling and general expenses related to the dinosaurs at $58,000 annually.
To manufacture the dinosaurs, the company must invest $350,000 in design molds and special equipment. Since toy fads wane in popularity rather quickly, Toying With Nature anticipates the special equipment will have a three-year service life with only a $20,000 salvage value. Depreciation will be computed on a straight-line basis. All revenue and expenses other than depreciation will be received or paid in cash. The company's combined federal and state income tax rate is 40 percent.
a.Prepare a schedule showing the estimated increase in annual net income from the planned manufacture and sale of dinosaur toys.
b.Compute the annual net cash flows expected from this project.
c.Compute for this project the (1) payback period, (2) return on average investment, and (3) net present value, discounted at an annual rate of 15 percent.
2. V. S. Yogurt is considering two possible expansion plans. Proposal A involves opening 10 stores in northern California at a total cost of $3,150,000. Under another strategy, Proposal B, V. S. Yogurt would focus on southern California and open six stores for a total cost of $2,500,000. Selected data regarding the two proposals have been assembled by the controller of V. S. Yogurt as follows:
Proposal A Proposal B
Required investment $3,150,000 $2,500,000
Estimated life of store locations 7 years 7 years
Estimated salvage value $0 $400,000
Estimated annual net cash flow 750,000 570,000
Depreciation on equipment (straight-line basis) 450,000 300,000
Estimated annual net income ? ?
a.For each proposal, compute the (1) payback period, (2) return on average investment, and (3) net present value, discounted at management's required rate of return of 15 percent.
3. Sonic, Inc., sells business software. Currently, all of its programs come on disks. Due to their complexity, some of these applications occupy as many as seven disks. Not only are the disks cumbersome for customers to load, they are relatively expensive for Sonic to purchase. The company does not intend to discontinue using disks altogether. However, it does want to reduce its reliance on the disk medium.
Two proposals are being considered. The first is to provide software on computer chips. Doing so requires a $300,000 investment in equipment. The second is to make software available through a computerized "software bank." In essence, programs would be downloaded directly from Sonic using telecommunication technology. Customers would gain access to Sonic's mainframe, specify the program they wish to order, and provide their name, address, and credit card information. The software would then be transferred directly to the customer's hard drive, and copies of the users' manual and registration material would be mailed the same day. This proposal requires an initial investment of $240,000.
The following information pertains to these proposals. Due to rapidly changing technology, neither proposal is expected to have any salvage value or an estimated life exceeding six years.
Computer Chip Software Bank EquipmentInstallation
Estimated incremental annual
revenue of investment $300,000 $160,000
Estimated incremental annual expense
of investment (including taxes) 250,000 130,000
The only difference between Sonic's incremental cash flows and its incremental income is attributable to depreciation. A minimum return on investment of 15 percent is required.
a.Compute the payback period of each proposal.
b.Compute the return on average investment of each proposal.
c.Compute the net present value of each proposal using the tables