Question

Santana Rey is considering the purchase of equipment for Business Solutions that would allow the company to add a new product to its computer furniture line. The equipment is expected to cost $342,000 and to have a six-year life and no salvage value. It will be depreciated on a straight-line basis. Business Solutions expects to sell 100 units of the equipment’s product each year. The expected annual income related to this equipment follows.

Sales	$	381,000
Costs
Materials, labor, and overhead (except depreciation)		199,000
Depreciation on new equipment		57,000
Selling and administrative expenses		33,500
Total costs and expenses		289,500
Pretax income		91,500
Income taxes (30%)		27,450
Net income	$	64,050

Required:
(1) Compute the payback period.

(2) Compute the accounting rate of return for this equipment.

Answer 1

Net income	64050
Add: Depreciation	57000
Annual net cash flows	121050
1
Cost of Investment	342000
/ Annual net cash flows	121050
Payback period	2.8	years
2
Annual after tax Net income	64050
/ Annual average investment	171000	=342000/2
Accounting rate of return	37.5%