Problem 16-20 Using the payback period and unadjusted rate of return to evaluate
ID: 2470850 • Letter: P
Question
Problem 16-20 Using the payback period and unadjusted rate of return to evaluate alternative investment opportunities LO 16-4
Austen Ren owns a small retail ice cream parlor. He is considering expanding the business and has identified two attractive alternatives. One involves purchasing a machine that would enable Mr. Ren to offer frozen yogurt to customers. The machine would cost $8,100 and has an expected useful life of three years with no salvage value. Additional annual cash revenues and cash operating expenses associated with selling yogurt are expected to be $6,200 and $900, respectively.
Alternatively, Mr. Ren could purchase for $10,080 the equipment necessary to serve cappuccino. That equipment has an expected useful life of four years and no salvage value. Additional annual cash revenues and cash operating expenses associated with selling cappuccino are expected to be $8,500 and $2,430, respectively.
Determine the payback period and unadjusted rate of return (use average investment) for each alternative. (Round "Payback period" to 2 decimal places. Round percentage answers to 2 decimal places (i.e., .2345 should be entered as 23.45).)
Austen Ren owns a small retail ice cream parlor. He is considering expanding the business and has identified two attractive alternatives. One involves purchasing a machine that would enable Mr. Ren to offer frozen yogurt to customers. The machine would cost $8,100 and has an expected useful life of three years with no salvage value. Additional annual cash revenues and cash operating expenses associated with selling yogurt are expected to be $6,200 and $900, respectively.
Explanation / Answer
1)
Payback period = Year up to which cummulative cash flow is negative +(cUMMulative cash flow of that year / cash flow of next period)
Alternative1 (PAyback period)
= 1 + (3320 / 4780)
= 1 + .69
= 1.69 years
Alternative = 1+ (4720 / 5360)
= 1 + .88
= 1.88 years
Unadjusted return :
Alternative 1 : = cash flow of each year/average investment
= 4780 / (8100+8100/2)
= 4780 / 8100
= .5901 or 59.01%
Alternative 2 = 5360 / (10080+10080/2)
= 5360 / 10080
= 53.17 %
Alternative 1 2 Depreciation 8100/3 = 2700 10080/4 = 2520 Income before tax 6200-900-2700 8500-2430-2520 =2600 =3550 less:Tax (.20*Income before tax) (520) [2600*.20] (710) [3550*.20] Income after tax 2080 2840 Add:Depreciation 2700 2520 cash flow 4780 5360