Question

Problem 12-26 Simple Rate of Return; Payback [LO12-1, LO12-6]

Sharkey’s Fun Center contains a number of electronic games as well as a miniature golf course and various rides located outside the building. Paul Sharkey, the owner, would like to construct a water slide on one portion of his property. Mr. Sharkey gathered the following information about the slide:

1. Water slide equipment could be purchased and installed at a cost of $360,000. According to the manufacturer, the slide would be usable for 12 years after which it would have no salvage value.
2. Mr. Sharkey would use straight-line depreciation on the slide equipment.
3. To make room for the water slide, several rides would be dismantled and sold. These rides are fully depreciated, but they could be sold for $97,500 to an amusement park in a nearby city.
4. Mr. Sharkey concluded that about 50,000 more people would use the water slide each year than have been using the rides. The admission price would be $3.90 per person (the same price the Fun Center has been charging for the old rides).
5. Based on experience at other water slides, Mr. Sharkey estimates that annual incremental operating expenses for the slide would be: salaries, $84,000; insurance, $4,700; utilities, $13,500; and maintenance, $10,300.

Required:

1. Prepare an income statement showing the expected net operating income each year from the water slide.

2-a. Compute the simple rate of return expected from the water slide.

2-b. Based on the above computation, would the water slide be constructed if Mr. Sharkey requires a simple rate of return of at least 13% on all investments?

3-a. Compute the payback period for the water slide.

3-b. If Mr. Sharkey accepts any project with a payback period of five years or less, would the water slide be constructed?

Answer 1

Concept- Inroduction

The simple rate of return is determined by taking the yearly steady networking operating income and dividing by the initial investment. While figuring the yearly steady net operating income, we have to make sure to lessen by the depreciation cost caused by the investment.

The payback period alludes to the measure of time it takes to recuperate the expense of a investment. Basically, the payback period is the timeframe a venture arrives at a make back the initial investment point.

The attractive quality of an investment is straightforwardly identified with its payback period. Shorter compensations mean increasingly appealing investment.

The payback period can be calculated as follow:

Payback period = Initial investment/ cash flow

1)

The Income statement for Sharkey's Fun center can be prepared as follows:-

Sharkey’s Fun Center
Income Statement
	Details (Amount)	Amount
Revenues
Incremental Revenues		$195,000
(50,000 × 3.90)
Selling and administrative expense
Salaries	$84,000
Insurance	$4,700
Utilities	$13,500
Maintenance	$10,300
Depreciation($360,000/12 years)	$30,000
Total Selling and Administrative expenses		$142,500
Net Income		$52,500

2)-a)

2)-b)

Yes. In light of the calculation over, the water slide will be built in light of the fact that the straightforward pace of profit for the venture is 20% which is more than the expected rate of 13%.

3)-a)

3)-b)

Yes. The payback period per the estimation is 3.18 years which is inside the necessities of Mr. Sharkey's. Accordingly, the water slide will be built.