v Santana Rey is considering the purchase of equipment for Business Solutions th

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Santana Rey is considering the purchase of equipment for Business Solutions that would allow the company to add a new product to its computer furniture line. The equipment is expected to cost $264,000 and to have a six-year life and no salvage value. It will be depreciated on a straight-line basis. Business Solutions expects to sell 100 units of the equipment’s product each year. The expected annual income related to this equipment follows.

Required:
(1) Compute the payback period.

(2) Compute the accounting rate of return for this equipment.

Sales $ 378,000 Costs Materials, labor, and overhead (except depreciation) 193,000 Depreciation on new equipment 44,000 Selling and administrative expenses 31,500 Total costs and expenses 268,500 Pretax income 109,500 Income taxes (35%) 38,325 Net income $ 71,175

Explanation / Answer

Answer to Part 1.

Payback Period = Initial Investment / Annual Cash Flow
Annual Cash Flow = Net Income + Depreciation
Annual Cash Flow = $71,175 + $44,000
Annual Cash Flow = $115,175

Payback Period = 264,000 / 115,175
Payback Period = 2.29 years

Answer to Part 2.

Accounting Rate of Return = Annual After Tax Net Income / Average Investment * 100
Average Investment = (264,000 + 0) / 2
Average Investment = $132,000

Accounting Rate of Return = 71,175 / 132,000 * 100
Accounting Rate of Return = 53.92%

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