Written Assignment Unit 6

Managerial Accounting
Case Study: A manufacturing company is evaluating two options for
new equipment

BUS 5110

University of the People

09/MAR/2022
Submit a written paper which is 3-4 pages in length (no more than 4-pages), exclusive of the
reference page.  Your paper should be double spaced in Times New Roman (or its equivalent)
font which is no greater than 12 points in size. The paper should cite at least three sources in
APA format.  One source can be your textbook.

Please describe the circumstances of the following case study and recommend a course of action.
Explain your approach to the problem, perform relevant calculations and analysis, and formulate
a recommendation. Ensure your work and recommendation are thoroughly supported.

Case Study:

A manufacturing company is evaluating two options for new equipment to introduce a new
product to its suite of goods. The details for each option are provided below:

Option 1 

 $75,000 for equipment with useful life of 7 years and no salvage value. 

 Maintenance costs are expected to be $2,500 per year and increase by 3% in Year 6 and
remain at that rate. 
 Materials in Year 1 are estimated to be $20,000 but remain constant at $10,000 per year
for the remaining years. 
 Labor is estimated to start at $50,000 in Year 1, increasing by 3% each year after. 

Revenues are estimated to be: 

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

   
-    50,000    125,000    150,000    150,000
113,000 125,000

Option 2 

 $50,000 for equipment with useful life of 7 years and a $10,000 salvage value 
  Maintenance costs are expected to be $4,500 per year and increase by 3% in Year 6 and
remain at that rate. 
 Materials in Year 1 are estimated to be $25,000 but remain constant at $20,000 per year
for the remaining years. 
 Labor is estimated to start at $70,000 in Year 1, increasing by 3% each year after. 

Revenues are estimated to be:

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

   
-    75,000    125,000    200,000    150,000
100,000 155,000

The company’s required rate of return and cost of capital is 8%.

Management has turned to its finance and accounting department to perform analyses and make
a recommendation on which option to choose. They have requested that the three main capital
budgeting calculations be done: NPV, IRR, and Payback Period for each option.

For this assignment, compute all required amounts and explain how the computations were
performed. Evaluate the results for each option and explain what the results mean. Based on your
analysis, recommend which option the company should pursue.

Superior papers will:

 Perform all calculations correctly.

 Articulate how the calculations were performed, including from where values used in the
calculations were obtained.
 Evaluate the results computed and explain the meaning of the results, including why
certain measurements are more accurate than others.
 Recommend which option to pursue, supported by well-thought-out rationale, and
considering any other factors that could impact the recommendation.

Be sure to use APA formatting in your paper.  Purdue University’s Online Writing Lab (OWL) is
a free website that provides excellent information and resources for understanding and using the
APA format and style. The OWL website can be accessed
here: https://owl.purdue.edu/owl/research_and_citation/apa_style/apa_style_introduction.h
tml

This assignment will be assessed using the BUS 5110 Unit 6 Written Assignment rubric.

Solutions:-
The net present value (NPV) is the value of future cash flows (both in and out) in today’s dollars,
present value calculations tell us the value of cash flows in today’s dollars.
The NPV method adds the present value of all cash inflows and subtracts the present value of all
cash outflows related to long-term investment. If the NPV is greater than or equal to zero, accept
the investment; otherwise, reject the investment (Heisinger & Hoyle, 2012). To calculate PV we
use the below equation:
P = Fn/(1+r)^n
P= present value
Fn = amount receive n years in future
r = annual interest rate
n = number of year

As we can see the NPV for option 1 is < 0 which means the investment is not acceptable and the
investment is generating a return less than the company required rate of return of 8%.

Now for option 2

As we can see the IRR is less than the company required rate of return, which means the
investment is not accepted.
For option 2

As we can see the IRR is less than the company required rate of return, which means the
investment is not accepted
The payback method evaluates how long it will take to pay back or recover the initial investment
and the payback period is the time in years that will take to generate enough cash from the
investment to cover the outflows for it (Heisinger & Hoyle, 2012). The good side of this analysis
is that manager will know how much time it will take to recover the initial investment, but the
downside for it is that it doesn’t consider the time value of money and it only considers the cash
inflows until the investment cash outflows are recovered.
BUS 5110: Managerial Accounting- Written Assignment Unit 6
IRR
For option 2 we can see that the payback period is more than 7 years, which is more than the
lifetime of the investment.
The average rate of return (ARR) is the average annual amount of cash flow generatedover the
life of an investment (Bragg 2018), and is calculated by the total cash inflow dividedby the
number of years as below:
ARR = (Total profit/numbers of years) / initial amount invested * 100
ARR = (54,000/7) / 65,000 = 0.11 = 11% FOR OPTION 1
ARR = (75000/7) / 85000 = 0.12 = 12% FOR OPTION 2
As we can see option 2 is more suitable because of its higher average return than
Option 1.
References
Bragg, Steven. “Average Rate of Return.” AccountingTools, AccountingTools, 30 Oct. 2018,
www.accountingtools.com/articles/2017/5/8/average-rate-of-return.
Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for Managers. Retrieved from
https://2012books.lardbucket.org/books/accounting-for-managers/index.html
average rate of return. (n.d.) Farlex Financial Dictionary. (2009). Retrieved May 20
2020 from https://financial-dictionary.thefreedictionary.com/average+rate+of+return