Question

Part 1 of 2 Required information [The following information applies to the questions displayed below.] 20 Nick's Novelties, Inc., is considering the purchase of new electronic games to place in its amusement houses. The games would cost a total of $332,000, have a fifteen-year useful life, and have a total salvage value of $33,200. The company estimates that annual revenues and expenses associated with the games would be as follows: points $ 280,000 eBook Hint Revenues Less operating expenses: Commissions to amusement houses Insurance Depreciation Maintenance Net operating income $80,000 57,000 19,920 60,000 216,920 $ 63,080 Ask Print References Required: 1a. Compute the pay back period associated with the new electronic games. 1b. Assume that Nick's Novelties, Inc., will not purchase new games unless they provide a payback period of five years or less. Would the company purchase the new games? Complete this question by entering your answers in the tabs below. Req 1A Req 1B Compute the pay back period associated with the new electronic games. Payback Period Years Req1A Req 1B >

Answer 1

7)

1a.    4 Years (4.04 Years)

Payback Period = Initial Investment / Net Annual cash inflow

Step 1: Computation of Annual Net cash inflow

          Here, the net operating income given is $63,080, but it is not the actual annual cash inflow. Here there is a non-cash expense(Depreciation). So, we will add back the depreciation to compute Net Annual cash inflow

                             = $63,080+$19,020

                             = $82,100

Step 2: Computation of Initial Investment made

         The price of new electronic games is $332,000 and the salvage value is included in the cost of Initial Investment because the entity is going to receive the amount at the end of life time and here we are computing the time period with which we can recover our Initial Investment . Hence, it is not reduced from Initial Investment

                            = $332,000

Step 3: Computation of Payback Period

                            = Initial Investment / Net Annual cash inflow

                            = $332,000 / $82,100

                            = 4.04 Years or 4 Years

1b.      Yes

Here the Payback Period is nearly 4 years (4.04) which is less than 5 years. So the Nick Novelties Inc. will purchase the game.