Question

A piece of labor-saving equipment has just come onto the market that Mitsui Electronics, Ltd., could use to reduce costs in one of its plants in Japan. Relevant data relating to the equipment follow:

Purchase cost of the equipment	$	432,000
Annual cost savings that will be provided by the equipment	$	90,000
Life of the equipment	12 years

Required:

1a. Compute the payback period for the equipment.

1b. If the company requires a payback period of four years or less, would the equipment be purchased?

2a. Compute the simple rate of return on the equipment. Use straight-line depreciation based on the equipment’s useful life.

2b. Would the equipment be purchased if the company’s required rate of return is 14%?

Answer 1

1a) Payback period = Initial investment/Annual cost saving = 432000/90000 = 4.8 year

1b) No, equipment should not be purchased

2a) Simple rate of return = Net income/Initial investment = 54000/432000 = 12.50%

2b) No, equipment should not be purchased