Homework SourseA piece of laborsaving equipment has just come onto the mark
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:
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%?
| Purchase cost of the equipment | $ | 392,000 |
| Annual cost savings that will be provided by the equipment | $ | 80,000 |
| Life of the equipment | 10 years | |
Solution
1a) Payback period = Initial investment/Annual cash flow
= 392000/80000
Payback period = 4.9 Years
1b) No, Equipment would not be purchased because payback period is higher than 4 years
2a) Simple rate of return = Net income*100/Initial investment
Net income = 80000-(392000/10) = 40800
Simple rate of return = 40800*100/392000 = 10.4%
2b) No, Equipment would not be purchased because simple rate of return is less than required rate of return
