A piece of labor-saving equipment has just come onto the market that Mitsui Elec

Question

A piece of labor-saving 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:

Required:

1a. Compute the payback period for the equipment.

1b. If the company requires a payback period of four years or less, would the equipment be purchased?

2a. Compute the simple rate of return on the equipment. Use straight-line depreciation based on the equipment’s useful life.

2b. Would the equipment be purchased if the company’s required rate of return is 16%?

Purchase cost of the equipment $ 392,000 Annual cost savings that will be
provided by the equipment $ 80,000 Life of the equipment 10 years

Explanation / Answer

1a) Payback period = Initial investment/Annual cash flow

   = 392000/80000

Payback period = 4.9 Years

1b) No, Equipment would not be purchased because payback period is higher than 4 years

2a) Simple rate of return = Net income*100/Initial investment

Net income = 80000-(392000/10) = 40800

Simple rate of return = 40800*100/392000 = 10.4%

2b) No, Equipment would not be purchased because simple rate of return is less than required rate of return

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