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Rate of return /payback period

Blue Ridge Furniture is considering the purchase of two different items of equipment as described below:

1. Machine A would permit Blue Ridge to compress sawdust into various shelving products. At present, the sawdust is disposed of as a waste product.The following info is available about the machine:

a) The machine would cost $780,000 and would have a 25% salvage value at the end of its 10 year useful life. The company uses straight line depreciation and considers salvage value in computing depreciation deductions.

b) The shelving products manufactured from the use of machine would generate revenues of $350,000 a year.Variable manufacturing costs would be 20% of sales.

c) Fixed Expenses associated with shelving products would be (per year): advertising $42,000, salaries $86,000, utilities $9,000, insurance $13,000

2. Machine B is used to automate a sanding process that was done by hand. The info is:

a) The new sanding machine would cost $220,000 and would have no salvage value at the end of its 10 year useful life. The company uses straight line depreciation on a new machine.

b) Several old pieces of sanding equipment that are fully depreciated would be disposed of at a salvage value of $7,200

c) The new sanding machine would provide annual savings in cash operating costs.It would require an operator at an annual salary of $26,000 and $3,000 in annual maintenance costs. The current hand operated procedure costs $85,000 per year.

Blue Ridge requires a simple rate of return of 16% on all equipment purchases. Also, the company will not purchase equipment unless the equipment has a payback period of 4 years or less.

Required:

Machine A
a) Contribution format income statement
b) Simple Rate of return
c) Payback period

Machine B
a) Simple rate of return
b) Payback period

According to the company criteria, which machine if either, it should purchase?

Solution Summary

The solution explains the calculation of simple rate of return and payback period in relation to purchase of machine

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