Question

Lakeside Inc. is considering replacing old production equipment with state-of-the-art technology that will allow production cost savings of $10,000 per month. The new equipment will have a five-year life and cost $420,000, with an estimated salvage value of $30,000. Lakeside’s cost of capital is 8%. Lakeside Inc. uses a straight-line depreciation method.

Required:
Calculate the payback period and the accounting rate of return for the new production equipment. (Round your answers to 2 decimal places.)

Answer 1

1. Payback period = Initial investment/ Annual saving

= $420000 / (10000*12) = 3.5 years

2.

Accounting rate of return = Annual saving / Average investment

= 120000 / (420000+30000)/2

= 53.33%