Question

A piece of laborsaving equipment has just come onto the market that Mitsui Electronics, Ltd., could use to reduce costs in one of its plants in Japan. Relevant data relating to the equipment follow:

  

Purchase cost of the equipment	$	530,000
Annual cost savings that will be     provided by the equipment	$	100,000
Life of the equipment		10 years

   

Required:

1-a.	Compute the payback period for the equipment.

	Payback Period Choose Numerator: / Choose Denominator: = Payback Period Annual net cash outflow / Investment required = Payback period $30,000 / $50,000 = 0.6 years

1-b.	If the company requires a payback period of four years or less, would the equipment be purchased?
	Yes No

	Simple Rate of Return Choose Numerator: / Choose Denominator: = Simple Rate of Return Annual incremental net operating income / Initial investment = Simple rate of return $320,000 / $56,000 = 571.4 %

2-b.	Would the equipment be purchased if the company’s required rate of return is 15%?
	Yes No

Answer 1

Answer to 1-a :
Payback Period
Choose Numerator	/	Choose Denominator	=	Payback Period
Investment Required	/	Annual Cost Savings	=	Payback Period
5,30,000	/	1,00,000	=	5.30
Answer to 1-b :
No, the equipment will not be purchased if the company requires a payback of four years or less as the payback period as computed above in 1-a is 5.3 years.
					Answer to 2-a :
Simple Rate of Return
Choose Numerator	/	Choose Denominator	=	Simple Rate of return
Annual incremental net operating income	/	Initital Investment	=	Simple Rate of return
1,00,000	/	5,30,000	=	19%
Answer to 2-b :
Yes the equipment will be purchased if the company's required rate of return is 15% since the rate of return earned from purchase of equipment is 19% as computed above in 2-a above.