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 $ 299,000 Annual cost savings that will be provided by the equipment $ 65,000 Life of the equipment 10 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 16%?

Answer 1

Solution:

1a.)

Payback Period = Investment Required / Annual Cash inflow
= $299,000 / $65,000
= $ 4.6 years

1b.)

No, equipment should not be purchased. Actual payback period with given information is 4.6 years.

2a.)

Annual cost savings = $65,000
Less: Annual Depreciation = $24,917
(299000/12)
Annual incremental net
operating income = $ 40,083

Simple rate of return = Annual incremental income / Initial investment
= $40,083 / 299,000
= 13.4%

2b.)

No, equipment required rate of return 13.4% is less than required rate of return 16%

answered by: anonymous