Nick\'s Novelties, Inc., is considering the purchase of new electronic games to

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 $175,000, have a fifteen-year useful life, and have a total salvage value of $17,500. The company estimates that annual revenues and expenses associated with the games would be as follows Revenues $200,000 Less operating expenses: Commissions to amusement houses insurance Depreciation Maintenance $80,000 25,000 10,500 60,000 175,500 --$ 24,500 Net operating income 2a. Compute the simple rate of return promised by the games. 2b. If the company requires a simple rate of return of at least 11%, will the games be purchased? Complete this question by entering your answers in the tabs below Req 2A Req 2B Compute the simple rate of return promised by the games. (Round your answer to 1 decimal place. i.e. 0.123 should be onsidered as 12.3%.) Simple rate of return Req 2A Req 2B

Explanation / Answer

2a. Simple rate of return =

(Incremental net operating income/Initial investment)*100

Incremental net operating income=incremental revenues less incremental expenses including depreciation.

So according to formula

=(24500/175000)*100

= 14%

2b.If company requires simple rate of return at least 11% then games should be purchased if it covers at least fixed costs that are depreciation and insurance of operating expenses that will remain same in each year amounts to $35500 and 11% means $19250(175000*11%) that is not covering even fixed cost so games should not be purchased.

Assuming insurance expense to be same in each year as generally it's a fixed cost.

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