Question

A piece of labor-saving equipment has just come onto the market that Mitsui Electronics, Ltd., could use to reduce costs in one of its plants in Japan. Relevant data relating to the equipment follow:

Purchase cost of the equipment	$	360,000
Annual cost savings that will be provided by the equipment	$	75,000
Life of the equipment	12 years

Required:

1a. Compute the payback period for the equipment.

1b. If the company requires a payback period of four years or less, would the equipment be purchased?

2a. Compute the simple rate of return on the equipment. Use straight-line depreciation based on the equipment’s useful life.

2b. Would the equipment be purchased if the company’s required rate of return is 15%?

Answer 1

Solution 1a:

Payback period = Initial investment / Annual cash inflows = $360,000 / $75,000 = 4.80 years

Solution 1b:

No, equipment should not be purchased as payback period offered by equipment is greater than 4 years.

Solution 2a:

Operating income from equipment = Net annual cost saving - Depreciation = $75,000 - ($360,000/12)

= $45,000

Simple rate of return = Operating income / Initial investment = $45,000 / $360,000 = 12.5%

Solution 2b:

No, equipment should not be purchased as return offered by equipment is less than 15%.

answered by: anonymous