Exercise 13-13 Basic Payback Period and Simple Rate of Return Computations [LO13

Question

Exercise 13-13 Basic Payback Period and Simple Rate of Return Computations [LO13-1, LO13-6] A piece of laborsaving equipment has just come onto the market that Mitsui Electronics, Ltd., could use to reduce costs in one of its plants in Japan. Relevant data relating to the equipment follow: Purchase cost of the equipment $ 600,000 Annual cost savings that will be provided by the equipment $ 100,000 Life of the equipment 12 years Required: 1-a. Compute the payback period for the equipment.

If the company requires a payback period of four years or less, would the equipment be purchased?

Compute the simple rate of return on the equipment. Use straight-line depreciation based on the equipment’s useful life.

If the company requires a payback period of four years or less, would the equipment be purchased?

Explanation / Answer

1.

Payback period for the equipment

Annual cost saving provided by equipment = $100000

Therefore payback period = $600000/$100000 = 6 years

If the company require a payback period of 4 years or less the equipment should not be purchased

2.

Straight line depreciation per year = $600000/12 years = $50000

Therefore net cost savings provided by equipment = $100000 - $50000 = $50000

Therefore, simple rate of return = $50000*100/$600000 = 8.33333%

If the company's required rate of return is 12% the equipment should not be purchased

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