Question

Sharkey's Fun Center contains a number of electronic games as well as a miniature golf course and various rides located outside the building. Paul Sharkey, the owner, would like to construct a water slide on one portion of his property. Mr. Sharkey gathered the following information about the slide: a. Water slide equipment could be purchased and installed at a cost of $345,000. According to the manufacturer, the slide would be usable for 12 years after which it would have no salvage value. b. Mr. Sharkey would use straight-line depreciation on the slide equipment. c. To make room for the water slide, several rides would be dismantled and sold. These rides are fully depreciated, but they could d. Mr. Sharkey concluded that about 50,000 more people would use the water slide each year than have been using the rides. e. Based on experience at other water slides, Mr. Sharkey estimates that annual incremental operating expenses for the slide be sold for $117,500 to an amusement park in a nearby city The admission price would be $3.80 per person (the same price the Fun Center has been charging for the old rides) would be: salaries, $83,000; insurance, $4,600; utilities, $13,400; and maintenance, $10,200. Required: 1. Prepare an income statement showing the expected net operating income each year from the water slide. 2-a. Compute the simple rate of return expected from the water slide. 2-b. Based on the above computation, would the water slide be constructed if Mr. Sharkey requires a simple rate of return of at least 12% on all investments? 3-a. Compute the payback period for the water slide. 3-b. If Mr. Sharkey accepts any project with a payback period of five years or less, would the water slide be constructed?

Answer 1

Sharkey's Fun Center Income Statement Ticket Revenue (50,000 $3.80 Less: Selling & Admnistrative expenses Salaries Insurance Utilities Depreciation (345,000/12 Maintenance Total Selling & Admnistrative ex Net Operating Income 190000 83,000 4,600 13,400 28750 10,200 1,39,950 50,050 2a) Simple Rate of Return Annual incremental net operating Income/ Intial Investment Simple Rate of Return $50,050/(345,000-117,500) Simple Rate of Return $50,050/227,500 Simple Rate of Return 22% 2b) Yes, the water slide should be constructed as the simple rate of return is more than 12%. Payback Period Intial Investment/Cash Inflow per period Cash inflow 50,050 +28,750 78,800 Payback Period 227,500/78,800 Payback Period 2.89 years 3b) Yes water slide should be construted as the payback period is less than 5 years.