Question

The Elberta Fruit Farm of Ontario has always hired transient workers to pick its annual cherry crop. Francie Wright, the farm manager, has just received information on a cherry picking machine that is being purchased by many fruit farms. The machine is a motorized device that shakes the cherry tree, causing the cherries to fall onto plastic tarps that funnel the cherries into bins. Ms. Wright has gathered the following information to decide whether a cherry picker would be a profitable investment for the Elberta Fruit Farm: a. Currently, the farm is paying an average of $230,000 per year to transient workers to pick the cherries. b. The cherry picker would cost $620,000, and it would have an estimated 8-year useful life. The farm uses straight-line depreciation on all assets and considers salvage value in computing depreciation deductions. The estimated salvage value of the cherry picker is $90,000. c. Annual out-of-pocket costs associated with the cherry picker would be: cost of an operator and an assistant, $90,000; insurance, $4,000; fuel, $16,000; and a maintenance contract, $14,000. Required: 1. Determine the annual savings in cash operating costs that would be realized if the cherry picker were purchased. 2a. Compute the simple rate of return expected from the cherry picker. 2b. Would the cherry picker be purchased if Elberta Fruit Farm’s required rate of return is 12%? Yes No 3a. Compute the payback period on the cherry picker. 3b. The Elberta Fruit Farm will not purchase equipment unless it has a payback period of six years or less. Would the cherry picker be purchased? Yes No

Answer 1

Required: 1. Determine the annual savings in cash operating costs that would be realized if the cherry picker were purchased.
Present cost of transient workers		$230,000.00
Less: out-of-pocket costs to operate the cherry picker:
Cost of an operator and assistant	$90,000.00
Insurance	$4,000.00
Fuel	$16,000.00
Maintenance contract	$14,000.00	-$124,000.00
Annual savings in cash operating costs		$106,000.00
2a. Compute the simple rate of return expected from the cherry picker
Annual savings in cash operating costs	$106,000.00
Less: annual depreciation ($620,000 -$90000) ÷ 8 years)	$66,250.00
Annual incremental net operating income	$39,750.00
Simple rate of Return =Annual incremental net operating income / Initial investment = $39,750/$620000	6.41%
b)
No, the cherry picker would not be purchased. The expected return is less than the 12% return required by the farm	NO
3a. Compute the payback period on the cherry picker
Payback period = Investment required / Annual net cash inflow
Payback period = $620,000 / $106,000	5.85	Years
3b. The Elberta Fruit Farm will not purchase equipment unless it has a payback period of six years or less. Would the cherry picker be purchased?
Yes, the cherry picker would be purchased. The payback period is less than 6 years	Yes