Perdue Company purchased equipment on April 1 for $270,000. The equipment was expected to have a useful life of three years

Perdue Company purchased equipment on April 1 for $270,000. The equipment was expected to have a useful life of three years, or 18,000 operating hours, and a residual value of $9,000. The equipment was used for 7,500 hours during Year 1, 5,500 hours in Year 2, 4,000 hours in Year 3, and 1,000 hours in Year 4.

Instructions

Determine the amount of depreciation expense for the years ended December 31, Year 1, Year 2, Year 3, and Year 4, by (a) the straight-line method, (b) the units-of-activity method, and (c) the double-declining-balance method.

Answer:

a. Straight-line method:

Year 1: ($270,000 – $9,000) ÷ 3 × 9 ÷ 12............................................. $65,250

Year 2: ($270,000 – $9,000) ÷ 3......................................................... 87,000

Year 3: ($270,000 – $9,000) ÷ 3......................................................... 87,000

Year 4: ($270,000 – $9,000) ÷ 3 × 3 ÷ 12............................................. 21,750

b. Units-of-activity method:

Activity rate = ($270,000 – $9,000) ÷ 18,000 hours = $14.50 per hour

Year 1: 7,500 hours × $14.50............................................................ $108,750

Year 2: 5,500 hours × $14.50............................................................ 79,750

Year 3: 4,000 hours × $14.50............................................................ 58,000

Year 4: 1,000 hours × $14.50............................................................ 14,500

c. Double-declining-balance method:

Year 1: $270,000 × 2 ÷ 3 × 9 ÷ 12...................................................... $135,000

Year 2: ($270,000 – $135,000) × 2 ÷ 3................................................ 90,000

Year 3: ($270,000 – $135,000 – $90,000) × 2 ÷ 3................................. 30,000

Year 4: ($270,000 – $135,000 – $90,000 – $30,000 – $9,000).................. 6,000

Note:  Book value should not be reduced below $9,000, the residual value.

Project A requires an original investment of $22,500. The project will yield cash flows of $5,000 per year for nine years

Project A requires an original investment of $22,500. The project will yield cash flows of $5,000 per year for nine years. Project B has a calculated net present value of $3,500 over a six-year life. Project A could be sold at the end of six years for a price of $12,000. (a) Determine the net present value of Project A over a six-year life, with residual value, assuming a minimum rate of return of 12%. (b) Which project provides the greatest net present value?

Answer:


a. Present value of $5,000 per year at 12% for 6 years*…………………………… $20,555 
Present value of $12,000 at 12% at the end of 6 years**………………………      6,084 
Total present value of Project A…………………………………………………… $26,639 
Less total cost of Project A…………………………………………………………   22,500 
Net present value of Project A……………………………………………………… $  4,139 
* [$5,000 × 4.111 (Exhibit 2, 12%, 6 years)] 
** [$12,000 × 0.507 (Exhibit 1, 12%, 6 years)] 
b. Project A. Project A’s net present value of $4,139 is more than the net present 
value of Project B, $3,500. 

A machine with a book value of $80,000 has an estimated five-year life. A proposal is offered to sell the old machine for $50,500

A machine with a book value of $80,000 has an estimated five-year life. A proposal is offered to sell the old machine for $50,500 and replace it with a new machine at a cost of $75,000. The new machine has a five-year life with no residual value. The new machine would reduce annual direct labor costs from $11,200 to $7,400. Prepare a differential analysis dated April 11, 2014, on whether to continue with the old machine (Alternative 1) or replace the old machine (Alternative 2).

Answer:

Differential Analysis 

Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) 

April 11, 2014 

 Continue 

with Old 

Machine 

(Alternative 1) 

Revenues:    

Proceeds from sale of old machine $ 0 $50,500 $50,500 

Costs:    

Purchase price 0 –75,000 –75,000 

Direct labor (5 years) –56,000I

ncome (Loss) –$56,000 –$61,500 –$  5,500 

    

1 

$11,200 × 5 years 

2 

$7,400 × 5 years 

The company should continue with the old machine.