Exercise 24-8 Payback period and accounting rate of return on investment LO P1,

Question

Exercise 24-8 Payback period and accounting rate of return on investment LO P1, P2

B2B Co. is considering the purchase of equipment that would allow the company to add a new product to its line. The equipment is expected to cost $240,000 with a 12-year life and no salvage value. It will be depreciated on a straight-line basis. The company expects to sell 96,000 units of the equipment’s product each year. The expected annual income related to this equipment follows.

1. Compute the payback period

2.Compute the accounting rate of return for this equipment

B2B Co. is considering the purchase of equipment that would allow the company to add a new product to its line. The equipment is expected to cost $240,000 with a 12-year life and no salvage value. It will be depreciated on a straight-line basis. The company expects to sell 96,000 units of the equipment’s product each year. The expected annual income related to this equipment follows.

Explanation / Answer

1.

Annual net cash flows = Net income + depreciation

= 17,500 + 20,000

= 37,500

Payback period = Investment / Annual net cash flows

= 240,000 / 37,500

= 6.4 years.

2.

Accounting rate of return = Accounting profit / Investment

= 17,500 / 240,000

= 7.29%.

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