Posted: April 24th, 2016

Why does the budget not include sales revenue and net income?

Problem #2
Bigtime Video is considering installing tanning beds in its video rental stores. The beds cost $200,000 and have an estimated six-year useful life. Ignore income taxes. The following pro forma income statement is provided:

Tanning bed revenue $ 86,000
Less expenses:
Bulbs, supplies, etc. $20,000
Insurance 10,000
Depreciation 24,000
Maintenance 6,000 60,000
Net income $ 26,000

Required:
1) Bigtime Video would like to recoup its original investment in less than five years. Compute the payback period for the tanning bed investment. Would you recommend that the beds be purchased? Why or why not?
2) Bigtime Video’s cost of capital is 12%. Compute the unadjusted rate of return on the original investment. Would you recommend that the beds be purchased? Why or why not?

Problem #3
Brady Company is considering the purchase of a new high-speed machine for its factory. The machine will cost $150,000 and will save the company $40,000 per year in cash operating costs. The machine has an estimated useful life of five years and no expected salvage value. The company’s cost of capital is 14%.

Required:
1) Compute the net present value of this investment.
2) What is the maximum amount that Brady should be willing to pay for the machine?
3) What are the minimum annual cash savings that will make the machine acceptable on a net present value basis if the purchase price is $150,000?

Problem #4
Caroline Farr is manager of a production department of Helling Company. Her department makes one product; the following information for her department was accumulated for 2012:

Static Budget Actual Results
Number of units 100,000 97,000
Direct materials cost $800,000 $792,000
Direct labor cost $400,000 $380,000
Variable manufacturing overhead $200,000 $199,000
Fixed manufacturing overhead $290,000 $292,000
Total $1,690,000 $1,663,000

Required:
a) Prepare a flexible budget for the department’s actual level of activity.
b) Use the flexible budget to evaluate Ms. Farr’s performance.
c) Why does the budget not include sales revenue and net income?