Nick’s Novelties, Inc., is considering the purchase of new electronic games to p

Question

Nick’s Novelties, Inc., is considering the purchase of new electronic games to place in its amusement houses. The games would cost a total of $380,000, have a fifteen-year useful life, and have a total salvage value of $38,000. The company estimates that annual revenues and expenses associated with the games would be as follows:

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2a. Compute the simple rate of return promised by the games.

2b. If the company requires a simple rate of return of at least 12%, will the games be purchased?

Revenues $ 300,000 Less operating expenses: Commissions to amusement houses $ 60,000 Insurance 65,000 Depreciation 22,800 Maintenance 80,000 227,800 Net operating income $ 72,200

Explanation / Answer

2a. The simple rate of return would be = Annual incremental net income / Initial investment

= $ 72,200 / $ 380,000

= 19%

2b. Yes, the games will be purchased as the 19% return exceeds 12%.

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