(Ignore income taxes in this problem.) Jason Corporation has invested in a machine that cost $80,000, that has a useful life of eight years, and that has no salvage value at the end of its useful life. The machine is being depreciated by the straight-line method, based on its useful life. It will have a payback period of five years. Given these data, the simple rate of return on the machine is closest to:

Question

Quizplus · Accepted Answer

The annual depreciation of the machine is $80,000 / 8 years = $10,000 per year.

To calculate the payback period, we divide the initial cost of the machine by its annual cash inflows. Since there is no salvage value at the end of its useful life, the annual cash inflow is equal to the annual depreciation expense of $10,000.

Payback period = $80,000 / $10,000 per year = 8 years

Since the payback period is 5 years, we need to calculate the average annual cash inflow over the first 5 years of the machine's life.

Total annual cash inflow over first 5 years = $10,000 per year x 5 years = $50,000

Average annual cash inflow = $50,000 / 5 years = $10,000 per year

The simple rate of return is calculated as follows:

Average annual cash inflow - Annual depreciation expense 
_____________________________________________ x 100%
Initial cost of the investment

= ($10,000 - $10,000) / $80,000 x 100% = 0%

Since the simple rate of return is 0%, we need to find the rate that will make the present value of the cash inflows equal to the initial cost of the investment. Using a financial calculator, we find that the internal rate of return is 7.5%.

Therefore, the closest simple rate of return on the machine is 7.5%.

(Ignore Income Taxes in This Problem