Question

Vaughn Service Center just purchased an automobile hoist for $34,000. The hoist has an 8-year life and an estimated salvage value of $3,400. Installation costs and freight charges were $4,200 and $800, respectively. Vaughn uses straight-line depreciation. The new hoist will be used to replace mufflers and tires on automobiles. Vaughn estimates that the new hoist will enable his mechanics to replace 5 extra mufflers per week. Each muffler sells for $77 installed. The cost of a muffler is $38, and the labor cost to install a muffler is $14. (a) Compute the cash payback period for the new hoist. Cash payback period years (b) Compute the annual rate of return for the new hoist. (Round answer to 2 decimal places, e.g. 10.52%.) Annual rate of return %

Answer 1

a. Cash payback period years = 6 years

b. Annual rate of return = 9.67%

Step-by-step explanation:

(a) Compute the cash payback period for the new hoist. Cash payback period years

Total cost of automobile hoist = Purchase cost + Installation costs + freight charges = $34,000 + $4,200 + $800 = $39,000

Weekly profit or cash inflow = (Muffler selling price per unit - Muffler cost per unit - Muffler labor cost per unit) * Number of extra muffler per week = ($77 - $38 - $14) * 5 = $125

Annual cash inflow = $125 * 52 weeks = $6,500

Cash payback period years = Total cost of automobile hoist / Annual cash inflow = $39,000 / $6,500 = 6 years

(b) Compute the annual rate of return for the new hoist

Annual depreciation expenses = (Total cost of automobile hoist - Estimated salvage value) / Useful years = ($39,000 - $3,400) / 8 = $4,450

Expected annual income = Annual cash inflow - Annual depreciation expenses = $6,500 - $4,450 = $2,050

Average investment = (Total cost of automobile hoist + Salvage value) / 2 = ($39,000 + $3,400) / 2 = $21,200

Annual rate of return = Expected annual income / Average investment = $2,050 / $21,200 = 0.0967, or 9.67%