Nick\'s Novelties, Inc., is considering the purchase of electronic pinball machi

Question

Nick's Novelties, Inc., is considering the purchase of electronic pinball machines to place in amusement houses. The machines would cost a total of $300,000, have an eight-year useful life, and have a total salvage value of $20,000. The company estimates that annual revenues and expenses associated with the machines would be as follows:


Revenues $200,000
Less operating expenses:
Commissions to amusement houses $100,000
Insurance 7,000
Depreciation 35,000
Maintenance 18,000 160,000
Net operating income $40,000
________________________________________

Requirement 1:
(a) Compute the pay back period associated with the pinball machines.

PAYBACK PERIOD _______ YEARS



(b) Assume that Nick´s Novelties, Inc., will not purchase new equipment unless it provides a payback period of five years or less. Does the company purchase the pinball machines?

YES OR NO



Requirement 2:
(a) Compute the simple rate of return promised by the pinball machines.


SIMPLE RATE OF RETURN __________%




(b) If Nick´s Novelties, Inc., requires a simple rate of return of at least 12%, does the pinball machines get purchased?


YES OR NO

Explanation / Answer

1.         Yes, the pinball machines would be purchased. The payback period is less than the maximum 5 years required by the company.

Payback period

=

Investment required

Annual cash inflow

Payback period

=

$300,000

=

4

Years

$75,000

2.         The simple rate of return would be:

Simple rate of return

=

Annual incremental net operating income

Initial investment

Simple rate of return

=

$40,000

=

13.33%

$300,000

            Yes, the pinball machines would be purchased. The 13.3% return exceeds 12%.

Payback period

=

Investment required

Annual cash inflow

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