Question

Asked May 12, 2019

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Santana Rey is considering the purchase of equipment for Business Solutions that would allow the company to add a new product to its computer furniture line. The equipment is expected to cost $371,000 and to have a seven-year life and no salvage value. It will be depreciated on a straight-line basis. Business Solutions expects to sell 100 units of the equipment’s product each year. The expected annual income related to this equipment follows.

Sales | $ | 375,000 | |

Costs | |||

Materials, labor, and overhead (except depreciation) | 195,000 | ||

Depreciation on new equipment | 53,000 | ||

Selling and administrative expenses | 30,000 | ||

Total costs and expenses | 278,000 | ||

Pretax income | 97,000 | ||

Income taxes (40%) | 38,800 | ||

Net income | $ | 58,200 | |

**Required:****(1)** Compute the payback period.

Payback PeriodChoose Numerator:/Choose Denominator:=Payback Period/=Payback period =0

**(2)** Compute the accounting rate of return for this equipment.

Accounting Rate of ReturnChoose Numerator:/Choose Denominator:=Accounting Rate of Return/=Accounting rate of return0

Step 1

**Payback Period:**

The payback period is a capital budgeting method which determines the time period required to recover the amount invested in an investment. It is the easiest method to evaluate an investment proposal. Formula to calculate the Payback Period is as follows:

**Accounting Rate of Return:**

Accounting rate of return (ARR) is a capital budgeting method which measures the effectiveness of an investment. It determines the Average rate of return or an annual rate of return from an investment. Formula to calculate ARR is as follows:

Step 2

1.

Given:

The initial investment is $371,000.

Net income is $58,200.

Depreciation is $53,000.

Calculation of Payback period:

Thus, the payback period of new equipment is **3.34 years**.

Working note:

Step 3

2.

Calculation of the accounting rate of return (ARR):

Note: Here we are taking initial in...

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