Question

B2B Co. is considering the purchase of equipment that would allow the company to add a new product to its line. The equipment is expected to cost $192,000 with a 12-year life and no salvage value. It will be depreciated on a straight-line basis. The company expects to sell 76,800 units of the equipment’s product each year. The expected annual income related to this equipment follows.

Sales	$	120,000
Costs
Materials, labor, and overhead (except depreciation on new equipment)		64,000
Depreciation on new equipment		16,000
Selling and administrative expenses		12,000
Total costs and expenses		92,000
Pretax income		28,000
Income taxes (30%)		8,400
Net income	$	19,600

1. Compute the payback period.
2. Compute the accounting rate of return for this equipment.

Answer 1

1.Payback period can be computed as:

Payback period=Cost of investment/Annual net cash flow

Annual net cash flows=net income+depreciation

Annual net flows=19,600+16,000=35,600

Payback period=192,000/35,600

Payback period=5.39%

2. Accounting rate of return can be computed as:

Accounting rate of return=Annual after tax net income/ Annual average investment

Accounting rate of return=19,600/(192,000/2)

Accounting rate of return=19,600/96,000

Accounting rate of return=20.42%

answered by: anonymous