Dobson Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income of $50,000. The equipment will have an initial cost of $500,000 and have an 8-year life. There is no salvage value of the equipment. The hurdle rate is 10%. Ignore income taxes. Calculate the following:a. Accounting rate of returnb. Payback period
What will be an ideal response?
a. 10% = $50,000/$500,000
b. 4.44 years = $500,000/($50,000 + [($500,000 ? $0)/8])
Accounting rate of return is calculated by dividing annual net income by initial investment. Payback period is calculated by dividing the initial investment by the annual net cash flow when cash flows are equal. Net income = Annual cash flows ? Depreciation.
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