Question

Saturn Ltd. wants to automate one of its production processes. The new equipment will cost $180,000. In addition, Saturn will incur installation and testing costs of $5,000 and $8,500 respectively. The expected life of the equipment is 8 years and the salvage value of the equipment is estimated at $18,000. The annual cash savings are estimated at $32,000. The company uses straight-line depreciation and has a required rate of return of 14%. Ignore income taxes. What is the payback period for the investment Saturn Ltd. is considering? A) 5.63 years B) 5.78 years C) 6.05 years D) 5.26 years E) The project does not payback. What is the accrual accounting rate of return for the investment Saturn Ltd. is considering? A) 5.2% B) 16.5% C) 4.0% D) 5.9% E) 11.0%

Answer 1

Answer

Cost of Equipment = Cost + Installation Cost + Testing cost

= $180,000 + 5,000 + 8,500

Cost of Equipment or Initial Cash Outflow = $193,500

Payback period = Initial Cash Outflow / Annual Cash Inflow

= $193,500 / 32,000

= 6.05 Years

Option C is Correct.

2.

ARR = Annual Income / Initial Investment

Depreciation = (Cost - Salvage Value) / No. of useful years

= ($193,500 - 18,000) / 8 Years

= $21,937.5

ARR = ($32,000 - 21,937.5) / $193,500

ARR = 5.20%

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