Ramson Corporation is considering purchasing a machine that would cost $756,000 and have a useful life of 8 years. The machine would reduce cash operating costs by $132,632 per year. The machine would have a salvage value of $151,200 at the end of the project. (Ignore income taxes.)Required:a. Compute the payback period for the machine.b. Compute the simple rate of return for the machine.
What will be an ideal response?
a.
The payback period is computed as follows:
Payback period = Investment required ÷ Annual net cash flow
= $756,000 ÷ $132,632 = 5.70 years
In this case the salvage value plays no part in the payback period because all of the investment is recovered before the end of the project.
b.
The simple rate of return is computed as follows:
| Annual incremental cost savings | $ | 132,632 |
| Annual depreciation ($756,000 - $151,200)/8 | 75,600 | |
| Annual incremental net operating income | $ | 57,032 |
= $57,032 ÷ $756,000 = 7.54% (rounded)
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