Problem 16-17 Using the Payback Period and Unadjusted Rate of Return to Evaluate Alternative Investment Opportunities
Quentin Giordano owns a small retail ice cream parlor. He is
considering expanding the business and has identifies two attractive
alternatives. One involves purchasing a machine that would enable him to
serve frozen yogurt to customers. The machine would cost $4,050 and has
an expected useful life of three years with no salvage value.
Additional annual cash revenues and cash operating expenses associated
with selling yogurt are expected to be $2,970 and $450, respectively.
Alternatively, he could purchase for $5,040 the equipment necessary to
serve cappuccinos. That equipment has an expected useful life of four
years and no salvage value. Additional annual cash revenue and cash
operating expenses associated with selling cappuccinos are expected to
be $4,140 and $1,215, respectively.
Income before taxes earned by the ice cream parlor is taxed at an effective rate of 20 percent.
A. Determine the payback period and unadjusted rate of return (use average investment.) for each alternative.
B. Indicate which investment alternative you would recommend. Explain your choice.
Check:
a. Payback Period of the Yogurt Investment: 1.77 Years
Unadjusted Rate of Return of the Cappuccino Investment: 52.86%
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