A piece of labor-saving equipm
A piece oflabor-saving equipment has just come onto the market that MitsuiElectronics, Ltd., could use to reduce costs in one of its plantsin Japan. Relevant data relating to the equipment follow:
| Purchase cost ofthe equipment | $ | 392,000 |
| Annual costsavings that will beprovided by the equipment | $ | 80,000 |
| Life of theequipment | 10 years | |
Required:
1a. Compute thepayback period for the equipment.
1b. If the companyrequires a payback period of four years or less, would theequipment be purchased?
2a. Compute the simplerate of return on the equipment. Use straight-line depreciationbased on the equipment’s useful life.
2b. Would theequipment be purchased if the company’s required rate of return is16%?
Answer:
1.
A) Purchase cost of the equipment = $ 392,000 , and the annualbenefit, i.e the cost saving being provided by the equipment is = $80000 per year.
The payback period refers to the simple, payback of theinvestment as a benefit in the number of years. It takes intoaccount the number of years taken to get back the invested amountignoring the effect of time lapsee or time value.
The formula used for Payback period calculation = Aountof Investment / Annual cash benefit.
Thus for the equipment payback period = $ 392000 / 80000= 4.9 years.
B) If the company requires a payback period of fouryears or less, would the equipment be purchased ? , here when thedecision is to be made only on the payback period, then theequipment should not be purchased as it takes more than 4 years topayback the initial investment.
2.
A) imple rate of return on the equipment , it is calculatedbased on the net operating profit or benefit after considering theeffect of depreciation . and the investment amount.
Here the cost = $ 392000 , and life of assets = 10 years, andstraight line method of depreciation is used,
depreciation under striaght line method =( Cost – salvage value) useful life = ( 392000 – 0 ) 10
Depreciation per year = $ 39200 per year .
So net operating income / Benefit = Cash Benfit – Depreciation =$ 80000 – 39200 = $ 40,800.
Thus Simple rate of return = Net operaating income /Investment amount = $ 40800 / 392000 = 10.41%
.Hence simple rate of return on the equipment =10.41%.
B) Would the equipment be purchased if the company’srequired rate of return is 16% , here the companies required rateof return is more than what it is actually providing, so thecompany should not purchase the equipment .
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