Answered Essay: B2B Co. is considering the purchase of equipment that would allow the company to add a new produ

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 $320,000 with a 12-year life and no salvage value. It will be depreciated on a straight-line basis. The company expects to sell 128,000 units of the equipment’s product each year. The expected annual income related to this equipment follows.

 

  Sales $ 200,000
  Costs
    Materials, labor, and overhead (except depreciation) 107,000
    Depreciation on new equipment 26,667
    Selling and administrative expenses 20,000
  Total costs and expenses 153,667
  Pretax income 46,333
  Income taxes (40%) 18,533
  Net income $ 27,800
1. Compute the payback period.

2. Compute the accounting rate of return for this equipment.

Expert Answer

 

1.

Payback Period
Choose Numerator: / Choose Denominator: = Payback Period
Cost of investment / Annual net cash flow = Payback period
$320,000 / $54,467 = 5.9 years

2.

Accounting Rate of Return
Choose Numerator: / Choose Denominator: = Accounting Rate of Return
Annual after-tax net income / Annual average investment = Accounting rate of return
$27,800 / $160,000 = 17.38%
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