Question

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.)

Answer 1

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