Question

Big Cat Company is considering the purchase of a new piece of equipment. Relevant information concerning the equipment follows:

Purchase cost: $180,000

Annual cost savings that will be provided by the equipment: $37,500

Life of the equipment: 12 years

(Ignore income taxes.)

Compute the payback period for the equipment. If the company rejects all proposals with a payback period of more than four years, would the equipment be purchased?

Compute the simple rate of return on the equipment. Use straight-line depreciation based on the equipment’s useful life, assuming $0 salvage value. Would the equipment be purchased if the company’s required rate of return is 14%?

Answer 1

	CACULATION OF PPAYBACK PERIOD
	Period	Particulars	Inflow (Outflow)	Cumulative Value
	0	Outflow	$         -1,80,000.00	$         -1,80,000.00
	1	Inflow	$               37,500.00	$         -1,42,500.00
	2	Inflow	$               37,500.00	$         -1,05,000.00
	3	Inflow	$               37,500.00	$             -67,500.00
	4	Inflow	$               37,500.00	$             -30,000.00
	5	Inflow	$               37,500.00	$                 7,500.00
	6	Inflow	$               37,500.00	$               45,000.00
	7	Inflow	$               37,500.00	$               82,500.00
	8	Inflow	$               37,500.00	$           1,20,000.00
	9	Inflow	$               37,500.00	$           1,57,500.00
	10	Inflow	$               37,500.00	$           1,95,000.00
	11	Inflow	$               37,500.00	$           2,32,500.00
	12	Inflow	$               37,500.00	$           2,70,000.00
		Total
	Payback Period = 4 Years+ $ 30,000 / $ 37,500
	Payback Period = 4 Years+ 0.80 Years
	Payback Period = 4.80 Years
	The above project have the payback period is more than 4 years so equipment will not be purchased
	Calcutaion of simple rate of return =
	Amount invested =			$           1,80,000.00
	Total Cost Saving = $ 37,500 X 12 =			$           4,50,000.00
	Simple rate of Return = Total cost saving / Amount invested
	Simple rate of Return =		$ 450,000 / $ 180,000
	Simple rate of Return =		250%
	CALCULATION OF THE PV OF THE INVESTMENT WITH 14%
	Value of the machiene =		$           1,80,000.00
	Life of the machine =		12 years
	Salvage =		Zero
	Depreciation per year = $ 180,000 / 12 = $ 15,000 per year
	Total Cost saving from the project per year =			$               37,500.00
	Add: Depreciation per year =			$               15,000.00
	Net Cash inflow from the equipment =			$               52,500.00
	Period	Particulars	Inflow (Outflow)	PVF @ 14%	Present Value
	0	Outflow	$         -1,80,000.00	1.00000	$         -1,80,000.00
	1	Inflow	$               52,500.00	0.87719	$               46,052.63
	2	Inflow	$               52,500.00	0.76947	$               40,397.05
	3	Inflow	$               52,500.00	0.67497	$               35,436.00
	4	Inflow	$               52,500.00	0.59208	$               31,084.21
	5	Inflow	$               52,500.00	0.51937	$               27,266.85
	6	Inflow	$               52,500.00	0.45559	$               23,918.29
	7	Inflow	$               52,500.00	0.39964	$               20,980.96
	8	Inflow	$               52,500.00	0.35056	$               18,404.35
	9	Inflow	$               52,500.00	0.30751	$               16,144.17
	10	Inflow	$               52,500.00	0.26974	$               14,161.55
	11	Inflow	$               52,500.00	0.23662	$               12,422.41
	12	Inflow	$               52,500.00	0.20756	$               10,896.85
			Total		$           1,17,165.34
	There is positive cash flow it means the equipment will be purchased