Question

Legend Service Center just purchased an automobile hoist for $27,600. The hoist has an 8-year life and an estimated salvage value of $3,500. Installation costs and freight charges were $4,100 and $800, respectively. Legend uses straight-line depreciation. The new hoist will be used to replace mufflers and tires on automobiles. Legend estimates that the new hoist will enable his mechanics to replace 5 extra mufflers per week. Each muffler sells for $74 installed. The cost of a muffler is $37, and the labor cost to install a muffler is $12. (a) Compute the cash payback period for the new hoist. Cash payback period years (b) Compute the annual rate of return for the new hoist. (Round answer to 2 decimal places, e.g. 10.52%.) Annual rate of return %

Answer 1

Part a)

Step 1: Calculate Initial Cost and Net Annual Cash Flow

The value of initial cost and net annual cash flow is arrived as follows:

Initial Cost = Purchase Price + Installation Costs + Freight Charges = 27,600 + 4,100 + 800 = $32,500

Net Annual Cash Flow = Number of Extra Mufflers*Number of Weeks*(Selling Price of Each Muffler Installed - Cost of Each Muffler - Labor Cost to Install a Muffler) = 5*52*(74 - 37 - 12) = $6,500

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Step 2: Calculate Cash Payback Period

The value of cash payback period is determined as below:

Cash Payback Period = Initial Cost/Net Annual Cash Flow = 32,500/6,500 = 5 Years (answer for Part a)

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Part b)

Step 1: Calculate Average Investment and Annual Net Income

The value of average investment and annual depreciation is calculated as follows:

Average Investment = (Beginning Value of Hoist + Ending Value of Hoist)/2 = (32,500 + 3,500)/2 = $18,000

Annual Net Income = Net Annual Cash Flow - Annual Depreciation = 6,500 - (32,500 - 3,500)/8 = $2,875

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Step 2: Calculate Annual Rate of Return

The annual rate of return is determined as below:

Annual Rate of Return = Annual Net Income/Average Investment = 2,875/18,000 = 15.97% (answer for Part b)