Question

Nick’s Novelties, Inc., is considering the purchase of new electronic games to place in its amusement houses. The games would cost a total of $475,000, have a fifteen-year useful life, and have a total salvage value of $47,500. The company estimates that annual revenues and expenses associated with the games would be as follows: Revenues $ 240,000 Less operating expenses: Commissions to amusement houses $ 70,000 Insurance 45,000 Depreciation 28,500 Maintenance 30,000 173,500 Net operating income $ 66,500 Required: 1a. Compute the payback period associated with the new electronic games. 1b. Assume that Nick’s Novelties, Inc., will not purchase new games unless they provide a payback period of five years or less. Would the company purchase the new games?

Answer 1

Answer:

     a. 5 years

     b. Yes they will because the payback period is 5 years.

Explanation:

a. Payback period

First calculate the annual cash inflow:

= Net income + Depreciation

= 66,500 + 28,500

= $95,000

The investment cost was $475,000

Payback period = Investment cost / Annual cash inflow

= 475,000 / 95,000

= 5 years

b. The company will purchase the games because they have a payback period of 5 years.