Exercise 11-6 Payback Period and Simple Rate of Return [L011-1, LO11-4] IThe fol

Question

Exercise 11-6 Payback Period and Simple Rate of Return [L011-1, LO11-4] IThe following information applies to the questlons displayed below Nick's Noveltles, Inc., Is consldering the purchase of new electronic games to place In lts amusement houses. The games would cost a total of S392,000, have an eight-year useful life, and have a total salvage value of $39.200. The company estimates that annual revenues and expenses assoclated with the games would be as follows: Revenues Less operating expenses: $270,000 Commisslons to amusement houses Insurance Depreclation Maintenance $60,000 52,000 44,100 60,000 216,100 Net operating income $53,900

Explanation / Answer

Part 1-A

Annual net cash flow = net operating income +non cash deduction for depreciation = 53900+44100 = 98000

Payback period

Part 1 B

Yes, the new games would be purchased. The payback period is less than maximum 11 years required by the company.

Part 2 A

Simple rate of return = annual Incremental net income / initial investment = 53900/392000 = 13.75%

Part 2 B

Yes, the games would be purchased. The 13.75% exceeds 13%.

Numerator / Denominator = payback period Investment required / annual net cash flow = payback period 392000 / 98000 = 4 years

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