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 $275,000 and to have a five-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. $380,000 cBook ferences Sales Costs Materials, labor, and overhead (except depreciation) Depreciation on new equipment Selling and administrative expenses Total costs and expenses Pretax income Income taxes (354) Net income 194,000 55, eee 33,000 282,000 98.000 34,300 $ 63,700 Required: (1) Compute the payback period, Payback Period Choose 1 Denominator: Payback Choose Numerator: Payback period < Prev 1 of 1 Next >

Answer 1

Solution: Santana Rey 1. Computation of Pay Back Period: Initial outlay for Capital Investment = $275,000 Net Annual Cash Inflow after tax = $118,700 Life of the Project = 5 years Calculation of Cash Inflow after Tax: Net Income after Tax = $63,700 Add: Depreciation 55,000 Cash Inflow after tax $118,700 But Before Depreciation Note: Depreciation is a non cash expense so it will be added Back to find cash inflow Pay Back Period - Initial Investment / Annual Cash Inflows = $275,000 / $118,700 = 2.3167 = 2.32 years

2. Calculation of Accounting Rate of return (ARR): ARR - Average Annual Net Income after Tax and Depreciation / Average Investment Initial Outlay = $275,000 Useful Life = 5 years Salvage Value = 0 Net Income = $63,700 (After tax and after depreciation) Total Net Income after tax and depreciation for 5 Years = $63,700 x 5 = $318,500 Average Annual Net Income after tax and Depreciation = $318,500 / 5 = $63,700 (a) Average Investment: = (Initial Investment + Salvage Value) / 2 = ($275,000 + 0)/2 = $137,500 Average Rate of Return = Average Net Income / Average Investment = $63,700 / 137,500 = 46.3272 % or say = 46.33%