Question

A piece of laborsaving 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	$	270,000
Annual cost savings that will be     provided by the equipment	$	60,000
Life of the equipment		12 years

   

Required:

1-a.		Compute the payback period for the equipment.
	Payback Period Choose Numerator: / Choose Denominator: = Payback Period / = Payback period / = years
1-b.		If the company requires a payback period of four years or less, would the equipment be purchased?
		Yes No

     

2-a.		Compute the simple rate of return on the equipment. Use straight-line depreciation based on the equipment’s useful life.
	Simple Rate of Return Choose Numerator: / Choose Denominator: = Simple Rate of Return / = Simple rate of return / = %
2-b.	Would the equipment be purchased if the company’s required rate of return is 15%?
	Yes No

Answer 1

1-a	Calculation of Payback period of equipment :-
a	Initial Investment (Cost of equipment)	=	$                                270,000
b	Estimated Annual Cash inflows (Annual cost savings that will be provided by the equipment)	=	$                                   60,000
c	Payback period (years) (a/b)	=	4.50
1-b	If the company requires a payback period of four years or less, would the equipment be purchased?
Ans:	No
Explanation:	Equipment has 4.50 years payback period which is higher than the required payback period. So, equipment should not be purchased.
2-a	Calculation of Simple rate of return for each product :-
	Simple rate of return	=	Annual Net Income
			Net Initial Investment
	Calculation of Annual Net Income:-
			Product A
a	Annual cost savings that will be provided by the equipment	=	$                                   60,000
b	Depreciation Expense (270000/12 years)	=	$                                   22,500
c	Annual Net Income (a-b)	=	$                                  37,500
			Product A
a	Annual Net Income	=	$                                   37,500
b	Initial Investment (Cost of equipment)	=	$                                270,000
c	Simple rate of return (a/b *100)	=	13.89%
2-b	Would the equipment be purchased if the company’s required rate of return is 15%?
Ans:	No
Explanation:	Equipment has 13.89% simple rate of return which is less than the required rate of return. So, equipment should not be purchased.

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