Question

If an equipment investment was $10,000 with a 5 year life using straight-line depreciation and provided an additionnal annual sales revenue of $3,500 and expenses (excluding depreciation) of $300, and the company is in a 50% tax bracket, the payback period is:

a. 3.13 years b. 3.85 years c. 1.67 years d. 16.7 years

The ARR is:

a. 12% b. 5.2% c. 6% d 2.6%

Answer 1

Solution:

Annual Depreciation = ($10000- $0) / 5 = $2,000

Annual Net Income Before Tax = Sales Revenue - Expenses - Depreciation = $3500 - $300 - $2000 = $1,200

Annual Net Income after tax = Annual Net Income Before Tax *(100%-50%) = $1200*50% = $600

Annual Net cash flows = Annual Net Income after tax + Depreciation = $600 + $2000 = $2,600

Now,

Payback period = Initial Investment / Annual Net cash flows = $10,000 / $2,600 = 3.85 years

Hence option "b" is correct.

Now,

Average Investment = (Initial Investment+ salvage value)/ 2= ($10000 +$0)/2 = $5,000

ARR = Annual Net Income after tax / Average Investment = $600/ $5000 = 12%

Hence option "a" is correct.