[The following information applies to the questions displayed below Nick\'s Nove

Question

[The following information applies to the questions displayed below Nick's Novelties, Inc., is considering the purchase of new electronic games to place in its amusement houses. The games would cost a total of $510,000, have an eight-year useful life, and have a total salvage value of $51,000. The company estimates that annual revenues and expenses associated with the games would be as follows: Revenues $220,000 Less operating expenses: $70,000 Commissions to amusement houses Insurance Depreciation Maintenance 25,000 57,375 40,000 192,375 Net operating income $ 27625

Explanation / Answer

.1 a calculation of payback period cash flows per year 1 revenue 220000 2 total revenue 220000 3 costs 4 commission 70000 5 insurance 25000 6 maintenance 40000 7 total costs 135000 135000 8 cash flows per year ( 220000 - 135000 ) 85000 9 salvage value at the end of the 8th year 51000 years 1 2 3 4 5 6 7 8 1 cash flows per year 85000 85000 85000 85000 85000 85000 85000 85000 2 salvage value 51000 3 total cash flows ( 1 + 2 ) 85000 85000 85000 85000 85000 85000 85000 136000 4 cumulative cash flows 85000 170000 255000 340000 425000 510000 595000 731000 initial cost 510000 payback period id the time required to collect the initial cash flows payback period is 6 years .1 b answer yes the company should purchase the new game , as the payback period is 6 years which is less than the required payback period of 9 years .2 a   cash flow per year 85000 less , depreciation 57375 net cash flow after deprecation ( 85000 - 57375 ) 27625 simple rate of return net cash flow / initial cost 27625/510000 5.42% .2 b answer no the company should not purchase the new game , as the simple rate of return 5.42 % is less than the required rate of return 11 %

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