Question

Required information

Exercise 12-8 Payback Period and Simple Rate of Return [LO12-1, LO12-6]

[The following information applies to the questions displayed below.]

Nick’s Novelties, Inc., is considering the purchase of new electronic games to place in its amusement houses. The games would cost a total of $350,000, have a fifteen-year useful life, and have a total salvage value of $35,000. The company estimates that annual revenues and expenses associated with the games would be as follows:

Revenues				$	220,000
Less operating expenses:
Commissions to amusement houses	$	90,000
Insurance		20,000
Depreciation		21,000
Maintenance		40,000			171,000
Net operating income				$	49,000

Exercise 12-8 Part 1

Required:

1a. Compute the payback period associated with the new electronic games.

1b. Assume that Nick’s Novelties, Inc., will not purchase new games unless they provide a payback period of five years or less. Would the company purchase the new games?

Answer 1

Annual cash flow = Net income+Depreciation = $49,000+$21,000 = $70,000

Payback period= Initial investment/Annual cash flow = 350,000/70,000 = 5 years

1b) Company should purchase the new game because payback period is 5 years