Fritz Company is planning to acquire a $250,000 machine to improve manufacturing efficiencies,thereby reducing annual cash operating costs (before taxes)by $80,000 for each of the next five years.The company has a minimum rate of return of 8% on all capital investments.The machine will be depreciated using straight-line method over a five-year life with no salvage value at the end of five years.Fritz is subject to a combined 40% income tax rate.
Required:
1.What is the machine's payback period,in years (rounded to two decimal places),under the assumption that cash flows occur evenly throughout the year?
2.What is the book (accounting)rate of return (ARR),based on the initial investment amount (rounded to one decimal point,that is,nearest one-tenth of a percent)?

Question

Quizplus · Accepted Answer

Feedback: 1.As indicated in the accompanying schedule (see below),the payback period occurs somewhere between year 3 and year 4.Under the assumption that after-tax cash inflows occur evenly throughout the year,a linear interpolation produces an estimate of 3.68 years,as follows: 3 + ($46,000/$68,000)= 3.68 years.Alternatively,payback period (in years)= original investment outlay/annual after-tax net cash inflow = $250,000/(increased annual pre-tax cash saving - additional income taxes per year)= $250,000/($80,000 - $12,000)= $250,000/$68,000 = 3.676 years (3.68,rounded).
2.As shown in the accompanying schedule (see below),average annual increase in after-tax income = $18,000.Original investment outlay = $250,000.Therefore,ARR = $18,000/$250,000 = 7.2%. 11ea6e70_bd0a_de6e_8f54_4f271942de3c_TB1699_00

Fritz Company Is Planning to Acquire a $250,000 Machine to Improve