Dracor Company is considering the purchase of equipment that would allow the company to add a new product to its line. The equipment is expected to cost $280,000 with a 7-year life, no salvage value, and will be depreciated using straight-line depreciation. The expected annual income related to this equipment follows. Compute the (a) payback period and (b) accounting rate of return for this equipment.Sales?$900,000?Costs:???Manufacturing$545,000??Depreciation on machine40,000??Selling and administrative expenses249,000(834,000)?Income before taxes?66,000?Income tax (30%)? ( 19,800)?Net income?$ 46,200?
What will be an ideal response?
a. Payback period = cost of investment/annual net cash flow; $280,000/$86,200 = 3.25 years
b. Accounting rate of return = Annual after-tax net income/annual average investment
$46,200/(($280,000 + 0)/2) = 33.0%
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