Question

Allison wants to automate one of its production processes. The new equipment will cost $90,000. In addition, Jupiter will incur installation and testing costs of $5,000 and $4,500 respectively. The expected life of the equipment is 5 years and the salvage value of the equipment is estimated at $12,000. The annual cash savings are estimated at $29,000. The company uses straight-line depreciation and has a required rate of return of 9%. Ignore income taxes.A. Calculate the payback period for the investment Jupiter Ltd. is considering?B. What is the accrual accounting rate of return for the investment Jupiter Ltd. is considering?

Answer 1

Jupiter Ltd.

A. The discounted payback period is:

= 3.2 years

B. The accrual accounting rate of return for the investment is:

= 57.79%

Step-by-step explanation:

a) Data and Calculations:

Cost of new equipment = $90,000

Additional costs:

Installation $5,000

Testing 4,500 9,500

Total cost of new equip. $99,500

Rate of return = 9%

Savings:

Salvage value, $12,000 discounted by 0.650 = $7,800

Annual estimated cash savings, $29,000 by 3.890 = $112,810

Total savings = $120,610

Annual equivalent savings = $31,005 ($120,610/3.890)

Discounted payback period = $99,500/$31,005 = 3.2 years

The returns from the investment:

Salvage value = $12,000

Cash savings = 145,000

Total savings = $157,000

Initial investment 99,500

Returns = $57,500

Accrual accounting rate of return = $57,500/$99,500 * 100 = 57.79%