Cardinal Pharmacy has purchased a small auto for delivery of prescriptions. The auto cost $28,000 and will be usable for four years. Delivery of prescriptions (which the pharmacy has never done before) should increase revenues by at least $40,000 per year. The cost of these prescriptions will be about $30,000 per year. The pharmacy depreciates all assets by the straight-line method. (Ignore income taxes.)Required:a. Compute the payback period on the new auto.b. Compute the simple rate of return of the new auto.
What will be an ideal response?
a.
Payback period = Investment required ÷ Annual net cash inflow
= $28,000 ÷ ($40,000 ? $30,000) per year
= $28,000 ÷ $10,000 per year = 2.8 years
b.
Simple rate of return = Annual incremental net operating income ÷ Initial investment
= [$40,000 ? ($30,000 + $7,000)] ÷ $28,000 = 10.7% (rounded)
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