Amazon Company has an old machine that is fully depreciated but has a current sa

Question

Amazon Company has an old machine that is fully depreciated but has a current salvage value of $5,000. The company wants to purchase a new machine that would cost $60,000 and have a five-year useful life and zero salvage value.

Expected changes in annual revenues and expenses if the new machine is purchased are:

            (Ignore income taxes in this problem.)

Required:

a) What is the payback period on the new equipment?

b) What is the simple rate of return on the new equipment?

Explanation / Answer

Solution :-

a) What is the payback period on the new equipment.

Machine initial cash outflow =

Purchase price of machine                 = $60,000

Less - Salvage value of old machine = $5,000

Net cash out flow                                  = $55,000

Increased in income                            = $18,000

Pay back period = $55,000 / $18,000

                             = 3.05 year.

b) What is the simple rate of return on the new equipment?

Incremental increase in net profit of $18,000 devided by initial investment of $55,000.

Therefore ;

Simple rate of return   = $18,000 / $55,000.

Then the project has a simple rate of return of 32.72%.

Note :- Depreciation is not add in net cash inflow because in question clearly state that "IGNORE INCOME TAX".

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