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In: Accounting

Lakeside, Inc., is considering replacing old production equipment with state-of-the-art technology that will allow production cost...

Lakeside, Inc., is considering replacing old production equipment with state-of-the-art technology that will allow production cost savings of $10,000 per month. The new equipment will have a five-year life and cost $390,000, with an estimated salvage value of $40,000. Lakeside’s cost of capital is 10%. Required: Calculate the payback period and the accounting rate of return for the new production equipment. (Round your answers to 2 decimal places.)

Solutions

Expert Solution

Ans. 1 Payback period = Initial investment / Annual cash inflows
$390,000 / $120,000
3.25 years
*Annual cash inflows = Cost savings per month * Number of months in a year
$10,000 * 12
$120,000
Ans. 2 Accounting rate of return =   (Annual cash inflow - Depreciation) / Average investment * 100
($120,000 - $70,000) / $215,000 * 100
$50,000 / $215,000 * 100
23.26%
*Depreciation =   (Cost of machine - Salvage value) / Useful life
($390,000 - $40,000) / 5
$350,000 / 5
$70,000
*Average investment =   (Cost of asset + Salvage value) / 2
($390,000 + $40,000) / 2
$430,000 / 2
$215,000
Ans. *Calculations for Present value of cash inflows:
Year PV @10% calculations PV @ 10% Cash inflows Present value of cash inflow
1 1 / (1 + 0.10)^1 = 0.9091 $120,000 $109,092.00
2 1 / (1 + 0.10)^2 = 0.8264 $120,000 $99,168.00
3 1 / (1 + 0.10)^3 = 0.7513 $120,000 $90,156.00
4 1 / (1 + 0.10)^4 = 0.6830 $120,000 $81,960.00
5 1 / (1 + 0.10)^5 = 0.6209 $120,000 $74,508.00
5 1 / (1 + 0.10)^5 = 0.6209 $40,000 $24,836.00
Total Present Value of Cash Inflows $479,720.00
Total Present Value of Cash Inflows $479,720.00
Less: Cost of equipment -$390,000
Net present value $89,720.00

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