PROBLEMIV Dyno-max is considering buying a new water treatment system for its pl

Question

PROBLEMIV Dyno-max is considering buying a new water treatment system for its plant in Austin Texas. The company screens its potential capital investments using the payback and accounting rate of return methods. If a potential investment has a payback of less than four years and a minimum 12% accounting rate of return, it will consider further follow: Cost of water treatment system Estimated residual value $48,000 Estimated annual net cash flow (each year for 5 years) from anticipated environment cleanup savings Estimated useful life 13,000 5 years Requirements Compute the water treatment system's payback Compute the water treatment system's ARR I. 2.

Explanation / Answer

1) Payback period = Initial investment/Annual cash flow

= 48000/13000

Payback period = 3.7 years

2) Accounting rate of return = Net income*100/Average investment

= 13000-(48000/5)*100/24000

Accounting rate of return = 14.2%

Average investment = 48000/2 = 24000

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